Since the turn of the millennium, there has been much interest in investing in gold do to an impressive price performance in this period. During this time, gold has well outperformed traditional investments such as stocks, bonds, and real estate. This trend is likely to continue as gold represents one of the true liquid ways to protect your portfolio against the dangers of central bank manufactured inflation.
Much of the increase in the price of gold over the past decade is due to a period of very loose monetary policy. Central banks around the world have dropped short term interest rates to levels close to zero, and long term interest rates worldwide are at record lows.
Normally this alone would expand the money supply at reasonably healthy levels. However the U.S. Federal Reserve and other central banks have engaged in an expanded policy of “quantitative easing” which involves creating money out of thin air to buy government backed securities. This has propelled monetary growth even further and has allowed the U.S. government to fund budget deficits over over $1 trillion at artificially cheap interest rates.
However, money printing by central banks has never ended well over the course of human history. In Weimer Germany it resulted in massive hyperinflation that created the economic morass that eventually brought Hitler into power. Much of the money created by the Federal Reserve remains on the sidelines due to incentives given to banks to keep reserves on deposit with the central bank. However, at the first hint of inflation that money could be rapidly deployed into hard assets which could accelerate the increase in price levels.
Gold has always been viewed as the canary in the coal mine when it comes to central bank excesses such as this. This is because gold is traditionally seen as “real money” as that has been its function for millenia. Its portability, scarcity, and durability make it a perfect long term store of wealth. Unlike Federal Reserve Notes, some central bank bureaucrat cannot just order the production of new gold pieces from thin air. These must be mined and refined in a costly extraction process from limited reserves across the world.
When interest rates are at historic lows, most asset classes are particularly vulnerable to inflation. This is because they are valued based on discounted cash flows, and the current low interest rate environment has lead to an artificially low discount rate. When inflation increases, that discount rate needs to adjust to at least match the inflation rate. As a result, even traditional inflation hedges such as commercial real estate and stocks can get hit. For fixed income investments such as bonds the outlook is even grimmer since the future payments are fixed in dollars.
Since there are few safe havens in the transition from low interest rates to high inflation, investing in gold will be one of the few options for money managers when the inflation arrives. As a result, the price of gold should increase well above the rate of inflation as money managers rush for the safety of gold. At this point, investing in gold might be the only decision that allows one to safeguard one’s personal wealth. Check out our review of Regal Assets here.