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Are Gold and Silver Really Protecting Value?

Special Report

Performance - In the Dollar?

In the U.S. institutional investors, in 2013, have sold off over 1,000 tonnes of gold holdings from the SPDR gold ETF, the investment banks, from the Gold Trust and from COMEX because they have switched from gold to equities in the U.S.

Nowhere in the world have gold investors followed U.S. investors, but have either held onto their gold or rushed in to buy up the physical gold made available to them. And this was done when prices were falling.

U.S. investors appear to have said there is no need to hold gold, we can make profits in a recovering U.S. economy. And so gold having fallen from above $1,650 to the low of $1,180 appears to have lost its wealth protective power. Or is it just out of cyclical favour?

Such an assessment overlooks it long-term role, but more importantly, its long-term value protection role. U.S. investors at institutional level have to account for their performance on a short-term basis, so usually do not have the option of investing for the long-term, riding the ebbs and flows of the day-to-day markets. And so they are not in a position to appreciate the real wealth protection value of gold. But the rest of the gold world outside the U.S. is keenly aware of its value. Hence their rush to buy physical gold as the U.S. sold it and prices fell.

So what value does gold and silver have to the foreign investors and is it relevant in these days?


Traditional Wealth Protection

To get a balanced sense of proportion in the gold world, please reflect on the reality that the U.S. accounts for around 8% of the demand for gold on an annual basis, whereas Asia as a whole accounts for around 65% to 75% of the demand for gold. The percentage that the U.S. takes this year may be higher as the demand for gold in jewelry should rise as prices are so much lower now.

But before the Indian government imposed its stringent controls on gold imports, India was headed to 1,800 tonnes of gold in imports according to their Finance Minister. China is still headed to imports of over 1,000 tonnes. All this against a total supply before prices fell of 4,500 tonnes of gold. At 8% the U.S. was a taker of 320 tonnes.

It now seems that the U.S. selling has slowed to a trickle not sufficient to restrain gold prices.


Role of Currencies in Wealth Protection.

Outside the reach of the U.S. dollar lie a host of currencies all founded on the same principles as the U.S. dollar. Each of them displays different and variable values, but currently each -before the coming changes to the global monetary system -are in some way dependent on the U.S. dollar. How? Well, in today's world as U.S. interest rates started rising, the prime impact of this interdependence was seen in the "Carry Trade's" activity. Traders (primarily the banks) have taken advantage of the low European and U.S. interest rates and borrowed in either the euro or the dollar and invested in the emerging world at very much higher interest rates. Provided Euro and dollar interest rates stayed low, and emerging world interest rates remained high, the profits were easy and reliable. The danger in such trades is the changeability of exchange rates. If emerging nation exchange rates fell then profits are wiped out quickly.

This highlights the value of gold. Locals usually have access to local gold markets without going through banks. Where they use banks they have a reasonable pricing of gold too, unless the government imposes taxes or duties. In general, gold is free of taxes such as VAT, so it can act as a currency hedge, particularly against your own currency.

This is where the true value lies in owning gold. Investors, looking ahead, have become keenly aware that the monetary aspect of gold is kicking in more and more in a growing number of countries. We take two examples to highlight this. The first is India and we look over the last two years:

  • For instance, in South Africa, in the last nine months the exchange rate against the U.S. Dollar has fallen from R6.80 to R9.9 which translates into a 46% rise in income to the mines there, against a fall in the gold price of 24%. This translates into a gold price rise of 22% in the Rand.

  • Cross to India where the gold price 2 years ago was Rs.71,350 when the Rupee cost Rs.44.08 and the dollar price of gold was 22% higher than today at $1,618.65. Today, with gold now lower at $1,324.35, in the Rupee it is now Rs.80,136 12.3% higher and the Indian Rupee at Rs.60.375 against the U.S. dollar.

Gold is therefore proving an excellent hedge against local currency depreciation even with a falling gold price! And this is the function it fulfils long-term.

But these two countries and their currencies are not the only ones to reflect this wealth protection facet.

The buying power of all currencies when taken back in time reflects a massive fall. When a country targets any level of inflation they are targeting a loss in buying power, and this is what gold protects against over the long-term.

The fall in the gold price in 2013 is a temporary correction, simply because the buying power of all currencies is designed to keep falling. Gold's long-term rising price compensates for that and will always do so.

 


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