Welcome to Finance and Fury,

 

Today – next gold rush – Final part of capital preservation –

  1. Allocation as a hedge for a financial meltdown – should preserve capital, withstand market volatility, and provide diversification across a portfolio
  2. Gold – an asset which is virtually permanent, with no significant erosion of quality over time, could arguably be considered a safe haven – good evidence that Gold has provided a hedge against collapse – limited supply at about 1.5% p.a. increase

 

What is Gold’s true role?

– Capital preservation – but also Money – Base money for most of history – 1912 when J.P. Morgan was called to testify before Congress.

  1. Congressman – I want to ask you a few questions bearing on the subject that you have touched upon this morning, as to the control of money. The control of credit involves a control of money, does it not?
  2. JP – A control of credit? No. – Congressman: But the basis of banking is credit, is it not?
  3. JP – Not always. That [credit] is an evidence of banking, but it [credit] is not the money itself. Money is gold, and nothing else.
  4. This is very interesting – our money now is credit – Fiat – not backed by gold

 

This is why people buy Gold – protect from these outcomes

  1. There are many uses including jewellery, electronics, dentistry, medical and other industrial use – and of course investment.
    1. Jewellery is the single-largest individual source of demand –
    2. 40% is investment purposes – bars, central bank reserves, ETFs
  2. Reasons for buying gold – Seen as safe haven when economy tanks
    1. Fear of an economic crisis or inflation outbreak fuelling public demand;
      1. Gold has historically served as a hedge against a declining US dollar and rising inflation
      2. Price of gold often moves in the opposite direction to the US dollar – reflecting the fact that many regard the yellow metal as an alternative currency
    2. A change in the sovereign wealth funds asset composition, such as demand from China, to diversify their holdings; and
    3. Negative bond yields losing their appeal as an effective hedge against equities.
      1. If Aus starts QE – gold goes well

 

Financial System – “Race to the bottom” fuels global demand for gold

Several fundamental drivers that enabled gold to break out – The gold price broke through the significant US$1,400 per ounce in June with several fundamental drivers:

  1. Continued tension between the US and China;
  2. US Federal Reserve (Fed) officials voicing concerns over the economy; and
  3. The weaker outlook globally – looks to be entering into another bull market
    1. A steady stream of weakening manufacturing data, beginning with falls in the Institute for Supply Management (ISM) Purchasing Managers’ Index (PMI) in the US and German industrial production sectors.
    2. Chinese authorities were also reported to be trying to contain the fallout from the failure of Baoshang Bank, as brokerages and asset managers were looking to restrict trading due to possible counterparty risks.
    3. Then the European Central Bank (ECB) indicated rate cuts are likely in the absence of any improvement in the economy

 

The economy can have a sort of Hard landing

Heading into 2020, we see one of two scenarios playing out across the markets:

  1. Soft landing – Manufacturing has been weak and on the verge of recession in China, Europe and now the US. A soft landing would occur if the global stimulus widely expected from central banks is able to keep a manufacturing recession from morphing into a broader recession across the entire economy.
    1. Averting a recession would be bullish for the stock market, interest rates would find a bottom, and the dollar would likely stabilise or strengthen. This might limit the upside for gold. In this scenario, we might see gold establish a new price range, supported by geopolitical risks and central bank demand.
  2. Hard landing – A hard landing occurs if the current manufacturing recession transitions into a broader economic recession, causing central banks to suffer a loss of confidence. US rates would likely fall to zero or less, and the stock market might enter a correction, while financial risks escalate. Central banks may restart quantitative easing (QE) or initiate other more radical policies. In this scenario, gold would probably form a positive price trend as a safe haven investment.
    1. Gold could gain from dangerous debt levels –
    2. Debt or overleverage is usually the culprit, as was seen with subprime mortgages in 2008.
    3. Global Gov debt surged following the financial crisis – Global gov funding is at Trillion-dollar shortfalls
      1. Expected next year and beyond – plus if a recession hits – tax receipts decline and expenses increase
      2. So the shortfall grows further with no way out – investors would no longer buy Treasuries = rates rise, credit may get downgraded and the US dollar may collapse.
    4. The second potential debt problem is corporate – As a percentage of GDP – corporate debt has now surpassed the peak of the last cycle in 2009
      1. Major risk in this cycle is lower credit standards – the amount of BBB rated corporate debt – the lowest category of investment grade – has more than doubled since 2009 – accounts for 55% of the investment-grade market – US$1 trillion of US debt is at risk of being downgraded to junk status
      2. Forces investment managers to sell – have to dumb debt as below investment grade – creates self-fulfilling decline
    5. Should a hard landing eventuate demand for gold and its miners is likely to increase. Despite the recent gold miners rally, gold stocks are historically cheap relative to the price of the metal.

 

How to gain exposure – 3 major ways

  1. Gold ETFs – Through ASX – Few to choose from
    1. Gain exposure to gold pricing – buy ETF share, then represents an ownership in gold – not same as direct
  2. Physical Gold – done through dealers or private companies
    1. Storage – Hiding it under the mattress or arrange for secure storage – comes with its own associated costs
    2. Bonus of this – hold an asset you can store outside of the banking system with a private company
      1. Best way to preserve wealth during times of financial turmoil.
    3. Holding physical bullion risky — and it can be – stolen or even melt in a house fire – requires adequate insurance
      1. Can purchase and store physical gold bullion using automated platforms 
  3. Gold mining companies/ETFs
    1. Another way of getting exposure is to invest in listed companies with exposure to gold.
      Australian-listed companies include large, long-life gold miner Newcrest Mining (ASX: NCM), and mid-size gold producer Regis Resources (ASX: RRL) – both of which currently screen as overvalued by Morningstar senior equity analyst Mathew Hodge.
    2. Unlike other vehicles, stocks can provide a dividend income, but naturally introduce other variables, including the quality of the mine life, the cost of getting the metal out of the ground, company earnings and other balance sheet considerations.
    3. With one trade on ASX GDX (VanEck) gives investors instant access to 44 of the largest and most liquid global gold mining companies.
      1. GDX is the world’s largest gold miners ETF with around A$15 billion in assets under management.

 

The Downsides –

  1. Gold itself as an asset class – not an income-producing asset – Costs for bullion storage
  2. ETFs – Counterparty risks at many levels – talked about this in previous ep – crisis assets
    1. Counterparty risk is present when another party in an agreement can default or fail to live up to their obligations
    2. Gold is meant to provide protection in collapse – but what if banks are collapsing – they are the counterparty
    3. Example – Buy ETF and gain exposure to the price of gold – Buying ETF through a large financial institution
      1. Responsible for obtaining the underlying assets necessary to create ETF shares – Gold
      2. Purchase gold as a trustee – then this trustee uses a custodian to source and store this – Custodian major counterparty – trustee is minor counter party
    4. If you buy gold as portfolio insurance against a systemic failure in the financial system – ETFs are intertwined with the world’s largest banks – doesn’t fit purpose well
      1. HSBC is the custodian for most ETFs in Gold – HSBC use sub-custodians, such as the Bank of England, to source and store gold. So, in addition to carrying custodian risk, investors also have sub-custodian risk.
    5. Technically – you are a shareholder of the Trust – access gold pricing – paper claim to gold
      1. The real irony is the price of gold could be skyrocketing and the ETFs could be going bankrupt at the same time.
    6. As such – if you are worried about a collapse of the financial system – direct gold would be better

 

Me – Have some gold mining – but only tiny allocation – risky model as costs involved with mining – so if prices drop 30% – likely lose more – Have Precious metals ETFs – Little more – but slowly buying more direct gold

 

Thank you for listening, 

If you want to get in contact you can visit www.financeandfury.com.au and head to the contact page

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