Markets Insight
November 7, 2012 12:04 pm
Fearful investors should stock up on gold
By Jim Slater
Gold usually rises in times of fiscal uncertainty, especially when such times lead to a big increase in money-printing and very low interest rates. Further price drivers are international crises, such as the Israel/Iran situation, the Syria/Turkey border incident, and the longer-term threat that the Muslim Brotherhood – which controls Egypt – will seek to extend its influence in the oil-rich countries in the Middle East tinderbox.
On the supply side, gold miners are running out of high-grade ore, there are problems with labour in South Africa, and both working and capital costs have risen. Central banks have stopped selling their gold and become big buyers.
A number of problems are close to tipping point. The most worrying is the risk that the Israelis may make a pre-emptive strike to delay Iran’s nuclear programme. It was thought this might happen before the US presidential election but seems to be more likely in 2013. This could be catastrophic, leading to war spreading in the Middle East and the possibility that Iran will block the Strait of Hormuz, resulting in the price of oil rising astronomically.
Second is the US annual deficit, which has come in at more than $1tn in each of the past four years. There is more than $16tn in outstanding Treasury debt, of which about half is owned by foreign creditors. Unfunded liabilities for social security, Medicaid and Medicare add a further $60tn.
The tipping point will be when overseas creditors realise the best they can hope for is to be repaid in much-depreciated US dollars. Bill Gross of Pimco believes that unless the fiscal gap is closed soon, “the damage will be beyond repair”. Pimco counsels investors to hold gold “as a compelling inflation hedge and store of value that is potentially superior to fiat currencies”. David Einhorn of Greenlight Capital, the US hedge fund he founded, has even stronger views, saying that “a large allocation to gold seems like a very good idea”.
Eurozone problems make daily headlines, with the obvious risk of the euro breaking up. Weak economies such as Greece can only recover if their currencies are allowed to depreciate to levels that enable them to be competitive. Their debts need to be written down sufficiently to give them a fresh start. Austerity programmes are necessary, but, coupled with too strong a currency, will never do the job. Pulling out of the euro and the European Union would save the weaker economies from sharing the substantial and rising costs of the European Commission and the large indirect costs of complying with the torrent of EU laws, rules and regulations.
An added European problem is the under-capitalisation of the banks, exacerbated by substantial holdings of European sovereign debt. It is highly likely that there will be more bank failures in Europe unless urgent action is taken to bolster bank reserves.
International unemployment is also reaching a tipping point. An increasing percentage of younger people, many of them with degrees, find it impossible to get jobs. In the eurozone more than 18m people are out of work, with a staggering 55.4 per cent of young people unemployed in Greece. In Madrid there have been violent protests. Unemployment on this scale is likely to lead to continued civil unrest and strikes.
Another acute financial problem is the undercapitalisation of pension funds. Medical advances have prolonged lifespans, while stock market returns have dwindled. According to Morgan Stanley, 84 per cent of UK defined benefit pension schemes are under water and liabilities exceed asserts by more than £300bn. Frightened trustees have switched from equities into bonds with minuscule current yields – an absurd policy that can only make things worse.
With a supreme effort, we might manage to solve one of these big problems and perhaps muddle through another one or even two. However, taking them together, the cumulative risk makes it highly likely that a few of the tipping points will be reached. Unfortunately, there is little investors can do other than sit it out and prepare their portfolios according to their hopes and fears.
For example, a fearful investor might put 40 per cent in cash, 15 per cent in gold and/or gold shares, 20 per cent in bonds and 25 per cent in equities. For the more hopeful and aggressive investor, 30 per cent cash, 10 per cent gold and/or gold shares and 60 per cent in equities would be more suitable.
Selection of equities is critical, of course. The focus should be on shares with rising earnings, relatively low price earnings ratios and strong cash flows.
Whatever the choice, let us hope that over the long term, equities will confound the bears and perform as well as they have in the past.
Jim Slater is an active private investor and former corporate raider.
On the supply side, gold miners are running out of high-grade ore, there are problems with labour in South Africa, and both working and capital costs have risen. Central banks have stopped selling their gold and become big buyers.
A number of problems are close to tipping point. The most worrying is the risk that the Israelis may make a pre-emptive strike to delay Iran’s nuclear programme. It was thought this might happen before the US presidential election but seems to be more likely in 2013. This could be catastrophic, leading to war spreading in the Middle East and the possibility that Iran will block the Strait of Hormuz, resulting in the price of oil rising astronomically.
Second is the US annual deficit, which has come in at more than $1tn in each of the past four years. There is more than $16tn in outstanding Treasury debt, of which about half is owned by foreign creditors. Unfunded liabilities for social security, Medicaid and Medicare add a further $60tn.
The tipping point will be when overseas creditors realise the best they can hope for is to be repaid in much-depreciated US dollars. Bill Gross of Pimco believes that unless the fiscal gap is closed soon, “the damage will be beyond repair”. Pimco counsels investors to hold gold “as a compelling inflation hedge and store of value that is potentially superior to fiat currencies”. David Einhorn of Greenlight Capital, the US hedge fund he founded, has even stronger views, saying that “a large allocation to gold seems like a very good idea”.
Eurozone problems make daily headlines, with the obvious risk of the euro breaking up. Weak economies such as Greece can only recover if their currencies are allowed to depreciate to levels that enable them to be competitive. Their debts need to be written down sufficiently to give them a fresh start. Austerity programmes are necessary, but, coupled with too strong a currency, will never do the job. Pulling out of the euro and the European Union would save the weaker economies from sharing the substantial and rising costs of the European Commission and the large indirect costs of complying with the torrent of EU laws, rules and regulations.
An added European problem is the under-capitalisation of the banks, exacerbated by substantial holdings of European sovereign debt. It is highly likely that there will be more bank failures in Europe unless urgent action is taken to bolster bank reserves.
International unemployment is also reaching a tipping point. An increasing percentage of younger people, many of them with degrees, find it impossible to get jobs. In the eurozone more than 18m people are out of work, with a staggering 55.4 per cent of young people unemployed in Greece. In Madrid there have been violent protests. Unemployment on this scale is likely to lead to continued civil unrest and strikes.
Another acute financial problem is the undercapitalisation of pension funds. Medical advances have prolonged lifespans, while stock market returns have dwindled. According to Morgan Stanley, 84 per cent of UK defined benefit pension schemes are under water and liabilities exceed asserts by more than £300bn. Frightened trustees have switched from equities into bonds with minuscule current yields – an absurd policy that can only make things worse.
With a supreme effort, we might manage to solve one of these big problems and perhaps muddle through another one or even two. However, taking them together, the cumulative risk makes it highly likely that a few of the tipping points will be reached. Unfortunately, there is little investors can do other than sit it out and prepare their portfolios according to their hopes and fears.
For example, a fearful investor might put 40 per cent in cash, 15 per cent in gold and/or gold shares, 20 per cent in bonds and 25 per cent in equities. For the more hopeful and aggressive investor, 30 per cent cash, 10 per cent gold and/or gold shares and 60 per cent in equities would be more suitable.
Selection of equities is critical, of course. The focus should be on shares with rising earnings, relatively low price earnings ratios and strong cash flows.
Whatever the choice, let us hope that over the long term, equities will confound the bears and perform as well as they have in the past.
Jim Slater is an active private investor and former corporate raider.
Copyright The Financial Times Limited 2012.
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