'Gold is my favourite currency'

Marc Faber, the legendary investor and the author of Gloom, Boom & Doom report shares his outlook on various asset classes including gold, agri-commodities and equities. Read on to know more

The only near-term factor in support of the US dollar is the fact that bearish sentiment is widespread, and that other paper currencies are also subject to their central banks’ printing machines, which on renewed economic weakness would also go into overdrive. As a result, my favourite currency remains gold, whose supply is extremely limited. In fact, I am wondering if gold, which is now at around $1,100 per ounce, is less expensive than when it sold for less than $300 per ounce. How could this be? I suppose that, in the same way that a company’s stock could be less expensive at $100 than when it was selling for $10, because earnings growth has outpaced the appreciation of the shares and therefore its P/E has declined, gold could be cheaper at the current price than when it was at less than $300 because of the explosion of foreign exchange reserves in the world, zero interest rates, the huge debt overhang, and the expectation of further money printing. International reserves have grown from about $1 trillion in 1995 to over $7 trillion.

Gold’s share in world’s reserves
As a result, the share of gold in the world’s official reserves has declined from 32.7 per cent in 1989 to a current record low of 10.3 per cent. As an aside, I am still puzzled by the deflationists, who cannot understand that the explosion in foreign exchange reserves over the last 15 years is a symptom of a massive monetary inflation. Ergo, I could argue that gold is now actually less expensive than when it sold for around $300 per ounce.

I should add that central banks in emerging economies keep only a tiny fraction of their reserves in gold. Eventually, I would expect them to follow the example of the Reserve Bank of India (RBI), which recently bought 200 tonnes from the IMF for $6.7 billion. The RBI, thus, increased the share of gold from 3.6 per cent of its $286 billion foreign exchange reserves to just over 6 per cent. (Guess who will be out of business first: the IMF or the RBI?)

Now, just consider what the impact would be if China were to increase its gold holdings from presently less than 2 per cent of its $2.2 trillion reserves to 6 per cent or 10 per cent. Each 1 per cent increase in gold weighting would mean gold purchases of more than $20 billion, or nearly 600 tonnes.

Its intrinsic value
I also find it encouraging that an economics professor, Willem Buiter, recently called gold a “barbarous relic” in a Financial Times blog. (Keynes had used the expression to refer to the gold standard). The good professor conceded that “its value may go from $1,100 per fine ounce to $1,500 or $5,000.” However, he stated that he “would not invest more than a sliver” of his wealth “into something without intrinsic value, something whose positive value is based on nothing more than a set of self-confirming beliefs”.

I am not entirely sure what the professor means by “intrinsic value”, but the fact remains that gold has been a currency for 6,000 years, whereas I am not familiar with any paper currency that has survived for more than a few hundred years. Moreover, it would seem that over time the “intrinsic value” (whatever the professor means) of paper currencies declines, whereas the “intrinsic value” of gold appreciates. (Maybe the professor should take the time to explain to us what the intrinsic value might be of a Gutenberg bible, a flawless 50 carat diamond, or a Picasso or Warhol painting).

The love for gold
I am not a perennial gold bug. But, when governments spend far more than they collect in taxes (large fiscal deficits), and when central bankers engage in reckless monetary policies and, instead of treating the causes of the problems (excessive debt growth), treat the symptoms (deflationary forces), gold as a currency does make a lot of sense. I need to clarify one point. When gold recently broke out on the upside above $1,000 per ounce I maintained that, whereas in the past the $1,000 level had been an area of resistance, with gold now above $1,000 it had become an area of support. I also said that if gold failed to hold above $1,000, I would become extremely concerned; and that in such a case a sell-off to $800 could not be ruled out, as failed breakout moves can lead to violent counter-movements. My feeling is that gold will hold above $1,000 and will trend higher over time. In fact, the breakout move of gold above $1,000 could be as significant as the decisive breakout move of the Dow Jones above the 1,000 level in early 1983.

The other options
Personally, I don’t think it is prudent to put all of one’s money in a single asset class that doesn’t provide a regular cash flow (dividends, rental income, and interest payments). Although gold has outperformed financial assets by a wide margin since 1999, there are also times when both equities and bonds outperform gold for an extended period of time. Equities have outperformed gold since March of this year. When central banks are debasing their currencies, equities do offer some protection against the loss of paper money’s purchasing power. In inflation-adjusted terms or in gold terms, the least expensive are agricultural commodities like soybeans, corn, and wheat. For investors who cannot purchase commodity futures, the other way is to buy agricultural product-growing companies or alternatively, fertiliser companies.

In equities though, investors seem to be obsessed with “what the stock market will do” because they focus almost entirely on stock market indices. There is a possibility that equity markets will move, in 2010 and thereafter, into a volatile trading range as was the case in the 1970s. The point I wish to make is that good stock selection is at least as important as, or even more important than, “guessing” where the markets will go. Even in recessions and down-markets, some companies can continue to thrive.

I think it is important to understand that in emerging economies, where markets are far from being saturated, companies that execute well can continue to grow even in a poor economic climate. So, investors should focus on identifying well-run and promising companies, and fund managers who are conservative, disciplined, and focused.

A final note about equities
Increasingly, I believe that the March 2009 lows will turn out to be major lows in nominal terms. I am certainly not in favour of it, but we have governments and central banks that will overwhelm the system with stimulus packages and will not hesitate to flood the financial sector with liquidity.

As the economist J.R. Hicks observed, “A depression … is most likely to occur when there is profound monetary instability — when the rot in the monetary system goes very deep”. Since none of the “rot” has been cleaned out, we can with great confidence and joy look forward to another, far bigger crisis down the road.

Still, I continue to notice a large number of stocks all over the world have recently broken out on the upside with heavy volume. I concede that some stocks have also broken down, but for now there seems to be a preponderance of upside breakout moves, which suggests that a bear market is not imminent. Therefore, I would still use market corrections as an opportunity to add to positions in fundamentally sound companies.