25 September 2018

Gold, reinvented in paper form?

Mercury was associated with commerce and negotiating and a simplified pictorial representation of the Caduceus was a symbol widely used by alchemists until the 18th century

Mercury was associated with commerce and negotiating and a simplified pictorial representation of the Caduceus was a symbol widely used by alchemists until the 18th century. There are some less classically inspired (and more probable) theories as to the origin of the $ symbol, however it is nice to think that alchemists’ otherwise fruitless efforts to turn base metal into gold may have had some lasting impact on the monetary system.

Historically gold was attractive because it was a currency and a store of wealth, whose value was not derived from a claim on a third party. A third party can always default, however a gold coin is money with its own imbedded collateral. In its purest form these attractions were manifestly true, for example a gold sovereign circulating during the classical gold standard of Victorian Britain.

Today gold is not money, it is a commodity. When Richard Nixon closed the gold window in 1971 the  final tenuous link between gold and money was severed. Since that date the price of gold in dollar terms has been every bit as volatile as any other commodity. Gold generates no yield so it cannot be valued based on future cash flows. It is often held out to protect against inflation but its own history strongly refutes that claim. Anyone who held gold between 1980 and 2000, a period of relatively high inflation, can painfully confirm this. Gold still has a modest role in a diversified portfolio as insurance against catastrophic risk, however it is a speculation on future commodity prices not a risk free store of wealth. What can fill the gap vacated by gold in the portfolio of the defensive investor?

Sadly there is no risk free store of wealth, however in our opinion, index linked bonds issued by the highest quality governments are as close to that description as can be achieved. Index linked bonds provide the holder inflation protected returns, with both the coupon and final maturity value of the bond increased by an inflation index, such as the consumer price index. Throughout the 1970’s many governments, including the UK, effectively defaulted on their debt by pursuing policies that generated high in ation; bonds were widely known as certificates of confiscation. Index linked bonds go a long way towards protecting against this inflationary risk that hangs over all conventional debt and cash.

Today gold is not money, it is a commodity.

Financial theory predicts that relatively low risk assets will deliver relatively low returns, and that is true for high quality index linked bonds. However every portfolio should contain a range of assets including some that will retain and increase their value even in the teeth of the worst financial crisis. Inflation linked bonds issued by high quality government issuers such as United States, Canada, Sweden, Australia, Germany and the UK fulfil that role. With some money safely tucked away, an investor is free to pursue higher risk and higher return opportunities elsewhere in their portfolio.

CG Asset Management is a boutique asset manager with a limited range of funds, all of which have a strong wealth preservation bias. The longest running of these funds, Capital Gearing Trust plc, has delivered 15% compound annual returns since 1982 with only one year of negative returns. Today Capital Gearing Trust plc has more than 30% of its assets in index linked bonds, as these instruments seem to us to be the best shelter from the storm we see coming when rising inflation causes long bond yields and equity prices to come under pressure. Great buying opportunities will present themselves in the future and it is important to have a little dry powder set aside to exploit them. What better way of doing that than holding the modern version of gold? 

Views and opinions have been arrived at by CG Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any products that may be mentioned

Illustration by Jordan Atkinson

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