Singapore (4 August 2020) – Warren Buffet doesn’t have an affinity towards gold. He once said,” It doesn’t do anything but sits there and look at you” when referring to gold. Thus, it is no surprise that he doesn’t believe in investing in gold as the yellow metal has limited real use (unlike silver which is widely used both in the electronic and health industries among others). In addition, gold doesn’t provide dividends but instead incurs storage costs when owned!
This conundrum stems from gold’s multi-facet characteristic – some see gold as a commodity, some as currency, many consider it an inflation hedge and others, a safe haven asset.
The challenge for gold is that when it is treated as a commodity, it faces the issue of “real use” as referred to by Warren Buffet. Given that gold doesn’t yield any form of dividends, it thus cannot be valued in the traditional manner, for example, using the discounted cash flow (DCF) method. And if one treats gold as an inflation hedge or even a safe haven asset, this would suggest gold is like insurance – a cost that is incurred only until some event occurs, for example, high inflation or crisis.
While gold does fit all these categories in some way or another, the one most suited is for it to be considered as a currency. In fact, gold has been throughout the centuries always been treated as such. It was not too long ago, that is in 1971, that the US Dollar was still convertible to gold at USD35 per ounce (until then U.S. President Nixon severed this direct international convertibility of the US dollar to gold).
Gold can be denominated in any currency but by default, it is paired against the US dollar. And like other currencies, the foreign exchange value of such pairings is basically a reflection of demand/supply of the currencies involved. For example, the USD/SGD is a reflection of the demand/supply dynamics that affect the USD versus SGD. Factors that could affect USD/SGD range from trade (US & Singapore trade), investments (net inflows between US & Singapore), economic (US economy vs Singapore economy), political (political situation in US vs Singapore), social (US vs Singapore handling of COVID19) etc.
So when we take this and apply it to gold, effectively we have a de facto USD/GLD currency where GLD is the currency of an imaginary country called Gold pitted against the USD, the currency of the United States of America. Side-by-side, the following characteristics stand out:
- The US has USD23.2trn worth of debt as of Q1 2020 (Chart 1). The country’s debt-to-GDP had surpassed the 100% level a few years ago (Chart 2). On the other hand, this country called Gold has no debt nor does it incur yearly fiscal deficits to add on its overall debt burden;
Chart 1: Total Public Debt
Chart 2: Total Public Debt as Percentage of GDP
- The Federal Reserve is continuing to debase the USD by printing more and more of the currency (Chart 3). On the other hand, gold does not have a central bank that can freely produce gold. Gold supply is kept stable (Chart 4) by natural stabilisers (e.g. not easy to find and it takes years to bring a new discovery to market), thus ensuring that it’s not debased like what many fiat currencies are experiencing today.
Chart 3: Federal Reserve Total Assets
Chart 4: Gold Production
On top of these issues, the US is also facing a myriad of issues ranging from social (protests), political (upcoming Presidential elections), medical (handling of COVID-19 crisis), geopolitical (China tensions) etc. These same issues do not exist for Gold.
In the next write-up we will look into what are some of the potential ways to determine the value of gold, that is, whether at current prices it remains over- or under-valued. -/-
Disclaimer: Mr Sani Hamid is a Director (Economy & Market Strategy) with financial advisory firm Financial Alliance and a Certified Financial Planner. He contributes to www.halaluniverse.net on a regular basis. The views, opinions and information expressed in this article are purely Mr Sani’s and are not to be construed as financial advice. Investors should seek advice from a financial adviser before investing.
