You Need Gold As Insurance Against A Financial System Crash

Precious metals have had an awful time recently.

The Federal Reserve is threatening to withdraw quantitative easing (QE). That’s been bad news for precious metals for two reasons.

Firstly, the end of money printing removes one of the more widely-cited reasons for holding precious metals. Secondly, the resulting strong US dollar tends to batter the commodities and precious metals sectors, because they are all by and large priced in dollars.

At MoneyWeek, we’ve moved from holding gold as an investment, to owning it as portfolio insurance. But is it even worth holding as insurance anymore?

I believe so, for reasons I’ll outline below. And if you’re a trader, now might even be a good time to take a little punt on gold

The Financial System is Being Rebuilt – Hold on to Your Insurance

As long-term readers of MoneyWeek will know, we’ve been suggesting people should own gold since the bull market took off in the early 2000s. Gold was clearly cheap. It was – not hated (as it is in some quarters now) – so much as defeated. The worst thing you could say about gold is that it wasn’t even despised. It just wasn’t on the radar.

Of course, it went up and up through the credit bubble of the 2000s. It then peaked in late summer 2011 at around $1,900 an ounce. If there’s one thing you could say about gold for sure, it was no longer cheap. It wasn’t necessarily massively overvalued either – but it was hardly off the radar. It was widely loved – and widely detested.

Later that year, my colleague Merryn Somerset Webb noted that she was taking some profits on her gold. Since then, we’ve viewed gold as portfolio insurance, rather than a value investment. Have about 5-10% of your portfolio in it. If everything goes horribly wrong with the global financial system, it’ll go up. That’ll be some consolation as everything else in your portfolio goes down.

If everything goes wonderfully right with the global financial system, your gold will go down in value. But you shouldn’t be too bothered, because the rest of your portfolio – your Japanese stocks, your cheap eurozone stuff, your US-exposed UK blue chips, and all the other stuff we’ve suggested you buy – will be going up.

To cut a long story short, that’s still our view. Insurance is insurance after all. You have it because you can’t predict the future.

That said, I probably wouldn’t feel as comfortable about having even a small holding in gold, if not for the fact that I think the threat of a nasty monetary surprise remains very high. I’m holding this insurance for a reason at the end of the day.

The global financial system is a rickety old thing. We need a new version. And en route, it’s likely to get chaotic and a bit scary.

I’ll explain what I mean. I spent yesterday at the Wired Money conference (if you don’t know, Wired is a glossy monthly magazine about technology. If you’re even remotely geeky – as I am – I thoroughly recommend it).

Most of the speakers were talking about ways to cut the middleman out of transactions – ‘peer-to-peer’ being the buzzword. Companies like Zopa, which enable you to lend money to individuals directly, without going through a bank. Or TransferWise – a really clever currency exchange service, that lets you swap your pounds for euros (or whatever) without being ripped off by banks or bureaux de change.

A lot of the services sounded great. There were lots of idealistic – but successful – entrepreneurs talking about how to make financial services that are focused on making the consumer’s life better, rather than ripping them off in the name of boosting profits. If I was running a bank, I’d be worried.

But what really struck me was that more and more people are questioning the very nature of money. Some speakers grappled with the role that trust plays in securing credit, or services. Others speculated on how the huge processing power we now have could feasibly make it possible to return to a barter economy, as trades can be so easily matched to one another.

It’s not just ‘cutting edge’ thinkers. You may or may not have noticed, but there’s been a rash of books recently, trying to explain what money is, and how it came to be.

The point is, our faith in the monetary system has been badly shaken. As a whole, our society realises that what it thought was a solid, reliable system, is actually built on very shaky foundations and riven with special interests. We’re also realising that it doesn’t necessarily have to be like that. At some level, we’re groping towards a redefinition of money.

The thing is, gold has a long history of being involved in the monetary system. I’m not saying for a minute that we’ll go back to a gold standard. That system had a lot of flaws too.

But revolutions tend to be messy things. So for as long as the nature of money and our financial system are being questioned and redesigned, I’m happy to hang on to an object that people have a long history of trusting as ‘money’.

A Trading Opportunity in Gold

So that’s my view on the long-term for gold. What about the short term?

Well, I’m no trader, so I wouldn’t normally bother bringing this up. And let me be clear – this is separate to holding gold as insurance. This is for someone who fancies a short-term punt that might turn a quick profit.

But in the short term at least, I do think my colleague John C Burford (who is a long-term gold bear) might be right in suggesting that a significant ‘bottom’ is either in, or nearly in, for gold.

You can read the piece yourself. But in short, John looked at the way that investors are positioned in the market, and noted that investors were pretty much as bearish last week as they were bullish at gold’s 2011 peak. So a contrarian would bet that the bears will have just about exhausted themselves.

Looking at the papers and internet over the weekend, I’d say he’s right. Sentiment in the media is a very tricky thing to gauge. But I think it’s fair to say that there was a bit of a ‘beargasm’ about gold at the weekend – lots of quotes about it being in freefall, lots of reports of ‘bloodbaths’ – even as the price started to recover.

John Stepek
Contributing Editor, Money Morning

This article first appeared in Money Week on 2 July, 2013

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