Friday, February 12, 2010

Gold Fever!

The price of gold has gone up a lot in 10 years. Many say it’s a bubble, many say it isn’t. Some say the mania phase is still ahead and give target prices that are multiples of the current spot price (~1090 dollars per troy ounce at the time of posting). I tend to agree with latter group (no bubble) and that is why I have exposed my portfolio partly to gold and gold miners.

Lately I have been taking hits because of this strategy as gold price has gone down and stocks of gold miners even more so. However, I intend to stick with the strategy because of the fundamentals backing gold. There are many reasons to own gold or any tangible things right now. In my mind, two of the biggest are fear of inflation and fear of another, a far more serious financial meltdown than experienced so far.

The measured inflation seems quite low right now, but my fear of inflation comes from “quantitative easing” (money printing) that has been going on for some time now. Please check the money supply charts from:

Compare them with the 10 year gold price chart below. Feel the connection?

Hardly scientific proof, but kind of makes you think..

If you are not familiar with the concept of fiat currency, why money printing is a problem or how this all relates to gold price, please check out this FAQ:

Currently all eyes are on Greece, but most western economies have debt issues. Budget deficits are not sustainable forever so something has to be done sooner rather than later. No growth goes on forever even though everybody seems to be obsessed with getting growth back on “track”. As if it would be “the silver bullet” to fix it all. It could be, but I don’t think so.

Seriously, a lot of manufacturing operations have moved to east permanently. They aren’t coming back any time soon. Also, lots of R&D is being moved to same direction. Growth in the past does not in any way guarantee that we have such thing far into the future. There is no such law for REAL growth anyway. Naturally, if inflation is 3% the economy better grow the same or then it is actually shrinking. So that explains partly the obsession with growth..

At any rate, the easiest fix to budget deficits, bank crisis etc. “surprises” will be more money printing for those who can do it. That equals serious problems at some point of time somewhere in the world. Be it asset bubbles or inflation or something else. Who knows?

So why should a private investor like myself care about any of this?

Well, exchange rates like USD/EUR have impact to bottom line of most companies. Some companies benefit from weak dollar, others suffer from it. However, the most interesting question is that in which currency you want to hold your long term investments.

This is where the barbaric relic comes into play. Even though gold is not used broadly as currency right now, it has been used as such in history and may be used once more. It is the ultimate benchmark for currencies. Or do you think that the central banks are sitting on it just for fun of it?

Since I don’t like to put my eggs in one basket only, I try to avoid getting too much exposure into any currency or gold for that matter. The problem with gold is that it does not yield anything – it is simply a tool to preserve wealth and take part in speculation regarding its value vs. fiat currencies. Betting on Chinese Yuan might also pay off someday, but when?

As most of my portfolio still is allocated to Europe and US, I am stuck with euro and dollar. But it does not hurt to acknowledge the problems that may lie ahead for fiat currencies.

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