The market expects the US Federal Reserve to increase interest rates in December, marking the first rate increase for nine years. As the returns from holding safe haven assets such as US government bonds increase then the attractions of gold are diminished.
Bad money drives out good
One of the most interesting reasons that can be linked to the falling gold price is to be found in “Gresham’s Law” that “bad money drives out good”. The Tudor financier, Sir Thomas Gresham, found that: “When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.”
Artificial currency devaluation is nothing new. It is as old as the pyramids themselves. Sir Thomas Gresham was merely drawing conclusions from the studies of the Islamic scholar and historian, Al-Maqrizi, who noted the effect of currency devaluation during the Mamluk empire in Egypt.
Al-Maqrizi observed the effect of a liquidity crisis on the Mamluk dynasty in the early 15th century that caused money circulation to dry up. The solution was mass enforced currency devaluation through replacing the gold-and-silver-based Dinar, with copper coinage, or Fulus, and for a period the Mamluk economy recovered rapidly as trade once again flowed freely.
However, inflation soon crept in and prices ran out of control as the currency was repeatedly debased. All the while gold hoarding was taking place behind the scenes.
Fast-forward half a century, and the money printing continues apace, while demand for physical gold is rising sharply. The latest government to devalue its currency to support the slowing economy has been China.
The People’s Bank of China is cutting interest rates and allowing the value of the Yuan to fall. Chinese citizens concerned about their loss of spending power are buying gold. Gold is simply the best insurance against inflation, or deflation.
Tight supply
The other long term support to the gold price is that when prices fall below $1,000 many miners will be forced to cut output. The gold mining industry invested millions in projects that are only profitable when prices are above those levels, and it has been absolutely hammered by falling prices.
Barrick Gold, the world’s largest miner of the metal that is listed in the US, has seen its shares fall as much as 30pc this year to a 25-year low. In London Randgold Resources shares are down 10pc, and Mexican precious metals miner Fresnillo has seen its shares fall 12pc.
The smaller listed miners had an even more turbulent time. Tanzanian gold miner Acacia Mining is down 38pc; and the Russian miner Petropavlovsk, which was founded by Peter Hambro, has seen its shares collapse during the past five years.
The best insurance
The easiest way to get access to gold are through low-cost funds. Popular physical gold exchange traded funds – or ETFs – include ETFS Physical Gold (PHGP) denominated in sterling and ETFS Physical Gold (PHAU) denominated in US dollars. Also BullionVault and GoldMadeSimple, offer low-cost services where small amounts of money can be deposited, which is then backed by gold.
For those who want to own physical gold coins or bars then there are established dealers such as ATS Bullion, BullionByPost, and Chard.
The Royal Mint has also extended its offering of gold and silver bullion to investors.
Questor wouldn’t recommend buying gold mining shares, or funds that invest in miners, as it is too high risk. The first rule of investing is capital preservation. And in the face of mass currency devaluation around the world then an allocation of about 5pc in assets such as gold looks sensible.
The future is uncertain and gold is the most effective insurance against that.
Written by Anonymous
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