Tags: gold | dollar | debt | ceiling

4 Time-Tested Tenets About Gold

By Friday, 18 October 2013 08:53 AM Current | Bio | Archive

With all the media attention on the government shutdown, debt ceiling and a new Federal Reserve chairman, it seems that for many investors, gold has taken a back seat.

But there are four time-tested tenets about gold that have been obscured by the current crises.

First, there is generally an inverse relationship between the value of U.S. dollar and the value of gold. When the dollar falls, the price of gold rises and vice versa.

There is risk to the dollar if our economic recovery is not robust. In fact, the recovery is modest and fragile. That makes it more difficult for the Fed to unwind their quantitative easing program without triggering inflation. Inflation devalues the dollar and thus increases the value of gold.

As a result, investors traditionally believe that owning some physical gold is useful as an insurance policy to cover any losses in the paper assets of their portfolio.

Second, gold has been used as a storehouse of wealth throughout history. Governments may come and go, financial institutions succeed or fail and currencies rise and fall. One thing remains constant: gold has always been worth something.

If Iran develops a nuclear weapon or the U.S. militarily intervenes in Syria, the Middle East would be in turmoil and our oil supplies at risk. A terrorist cyber attack crippling our banking system and making our electronic currency disappear and credit cards useless would put the United States in turmoil. A default of the United States would jeopardize the standing of the U.S. dollar, increase our borrowing costs and tip us back into a recession.

In times like these, prudent investors diversify their portfolios when there is uncertainty and instability. Setting aside a part of your portfolio in physical gold ensures that you will have something for a rainy day.

Third, while gold has fallen out of fashion in the United States and Europe, countries that have a long history of devalued currency and instability have been buying up gold like there is no tomorrow.

China just overtook India as the world's largest purchaser of physical gold. India might have kept the No. 1 spot except Indians were buying so much gold, it resulted in a huge trade deficit that began devaluing the rupee and the Indian government had to temporarily ban gold imports. In addition to Russia, Vietnam, Singapore and Malaysia and other Asian countries have seen their gold purchases ramp up significantly among individual investors and their central banks.

And fourth, the price of gold correlates best with the federal debt ceiling. As our debt rises to meet each debt ceiling, the price of gold has risen accordingly.

Our fiscal policy remains in shambles, with the United States having to borrow 25 cents for every dollar it spends. The recent budget deal kicks the can down the road to January.

Do we really think that the latest attempt to negotiate and pass a meaningful budget will end up any differently that have all the other attempts over the past five years?

It will likely take decades to produce a balanced budget, let alone a budget surplus. That means that we will be piling on the debt as far as the eye can see. And if historical precedent holds, that means the price of gold will rise accordingly.

Investors are breathing a sigh of relief that the crises du jour has been temporarily solved. The government re-opened and the new debt ceiling will last until early next year. The Fed chair nominee will be confirmed.

But savvy investors will ignore the hype. They know that the root problems that created the latest crises have not changed at all. Neither have these four time-tested tenets about gold.

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With all the media attention on the government shutdown, debt ceiling and a new Federal Reserve chairman, it seems that for many investors, gold has taken a back seat.
Friday, 18 October 2013 08:53 AM
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