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What’s up with Gold?

In the spring of 2009, when Canada was riding high on the commodities boom, the buying binge in gold exchange-traded funds and futures was estimated to be 100% of the actual mine supply. In July of 2013, with US government debt declining and the US dollar strengthening, the stampede to the exits from gold peaked at the same extreme level – 100% of the actual mine supply. Quite a change in five years! Does that mean the gold rush is over? What about all the talk (fear mongering?) about gold as the only way to preserve your wealth in the face of relentless inflation?

Should you be holding or adding precious metals or gold bullion mutual funds to your investment portfolio or should you be turning your attention entirely to the roaring equity markets?

As always the answer depends on your personal circumstances, but here are a few things to consider from the perspective of growth potential as well as risk management and portfolio diversification.

1) Global currencies: It used to be that the value of a country’s currency was based on the amount of gold that the central bank had in its vault. There is no longer a “gold standard” upon which to base the value of the paper money used around the world. The US dollar serves as the world’s reserve currency, and earns this position because it is an economic powerhouse with significant financial flexibility. However, the US government debt is very high (Gross general government debt is 110% of US GDP). It remains to be seen whether the US can engineer their way out of their long-term debt crisis without a serious loss of value of the US dollar. Unlikely as it may seem, many economists argue that a return to the gold standard is going to be required.

2013-05-06-china-currency-war_72px2) Demand for gold: Central banks are continuing to buy gold. It is reported that China has traded $70 billion USD this year for gold. Chinese demand for gold is more than 55% of global gold production. As China takes measures to internationalize its currency, it is speculated that China wants to use the yuan for global trade, competing with the US dollar as a reserve currency. To achieve this, it is estimated that China needs another 16,800 tonnes of gold in reserves, which is the equivalent of six years of global gold output. (Enjoy the cartoon used with permission of the American firm Merk Investments.)

3) Supply of gold: The price of gold has declined so much that it is close to the cost of production (US$1200/oz). This is resulting in closure of marginal mines and deferral of new projects, which leads to less overall production. With supply decreasing and demand increasing, the most likely result will be an increase in the price of gold.

4) Portfolio diversification and risk management: Gold does not generally trend in the same direction as the equity markets. While your precious metals or gold bullion fund may not perform in rising equity markets, you may want to have it there as a form of insurance. When inflation comes, the purchasing power of your dollar will be diminished. With artificially low interest rates in the US (repressed by the actions of the central bank, the US Federal Reserve), it is unclear when inflation will come – but just in case paper currencies in the developed nations decline in value, you need a little insurance. An allocation of 5% of your portfolio would be sufficient. We don’t know what the future holds.

If you want to discuss this blog or obtain references for more detailed information, please let me know. Although I don’t personally subscribe to the extreme views regarding the US debt, I have found over the years that it is beneficial to think about points of view which conflict with your own assumptions. I hope you find this blog thought-provoking.

 

The information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Jan Fraser, Life Aligned Investing of Aligned Capital Partners Inc. (ACPI) from sources believed to be accurate. The opinions expressed are those of the author and do not necessarily represent those of ACPI.

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