45 years ago, the world got off the gold standard and entered into an era of fiat currencies. So what does that make of the significance of gold for an investor?
We are joined by Mr. Prashant Trivedi, the Chairman of Multi Act group, who advises the prudent steps for an investor for insuring his portfolio against impeding storms, especially in the current economic scenario.
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In this podcast, we discuss:
1. The history of gold and US dollar de-linking
2. The before and after of the gold standard
3. Whether gold is for capital appreciation or for preservation
4. Cases of hyperinflation and deflation, and the role of gold in portfolio in those cases
5. The proportion of portfolio to be invested in gold for insurance
6. Latest market weather report
Read the Transcript of this Podcast:
Today, we are joined by Prashant Trivedi, the Chairman of Multi-Act group. Prashant, how do you look at gold from a portfolio perspective?
We’ve always maintained at Multi-Act that gold should be viewed – first and foremost – as insurance. So, what we’ve said is that if you think about holding gold as insurance, and then if you put about 10% of your portfolio in gold as insurance, it actually protects you to the right extent in either a hyper-inflationary or an inflationary environment, or a deflationary environment.
Let’s look at the last few historical episodes. From 1930 to 1939, in the United States, and to a certain extent globally, we had a deflationary environment. Equities fell by almost 90% from their peak period in 1929. Almost every other asset class fell by close to 90% – some of it may even be 70-60% (for example, bonds fell by 60-70% because of credit reasons). Most of the average equity fell by 90%. And in many cases, it actually got completely wiped out. The price of gold, on the other hand, actually increased from $20 to an ounce of gold to $35 to an ounce of gold. In nominal terms, it increased by 35%-40%. So by owning 10% of your portfolio in gold, let’s assume something similar happens. You effectively protect your portfolio to the same level it was before the depression. Because that 10% will appreciate by 10 times relative to every other asset class (like it did in the aforementioned case). So in real terms, you’ve maintained the value of the portfolio to what it was before a deflationary episode like that.
Let’s take an inflationary period. So in 1971 – and the signs were there even before that – when the world went off the gold standard completely, because Richard Nixon broke the link between the exchange of dollars by other central banks into gold. We had an inflationary period until 1981 in which the price of gold went up by 20 times. And at the same time, a lot of equities in nominal terms remained more or less the same. Obviously, there was inflation in other asset classes as well, but gold went up by 20 times. So relative to everything else, gold went up by at least 10 times if not more. So, again, by having 10% of your portfolio in gold at that particular instance, you’ve managed to preserve the real value of your portfolio.
Effectively, if you take the last few episodes, historically speaking, of either a deflationary or an inflationary environment – by inflationary environment, I mean an inflation rate greater than 10% – then in both those instances, gold actually did the function of insuring the portfolio. That’s why we’ve always maintained that especially in times of great monetary turmoil, or the potential for great monetary turmoil; you want to make sure that you have at least 10% of your assets in gold.
In the present era of easy money, with a series of quantitative easing, zero or even negative interest rates, why is it more important to have exposure to gold?
There is no doubt in my mind – and I think if any observer of what’s going on is objective, there’s no doubt – that we are living in a time of great monetary turmoil. It’s not that these interest rates are so low or negative by choice or through voluntary exchange, but because the central banks are almost force-feeding negative rates or lower and lower rates by continuing to buy up all bonds from the marketplace, and forcing those rates down. Now, if you think about it, you can understand why this is an absurd situation.
Because literally, one arm of the government – which is the central banks – is creating bank reserves out of thin air, and using those bank reserves to buy in bonds from the marketplace. It’s effectively just a circular transaction, right? Because you are creating liabilities out of thin air, and using those liabilities to buy in or purchase assets from the marketplace. And, again, if you pay a little bit of attention to that circular flow, you will realize that that can’t possibly represent any form of real money or any form of a store of value or the functions that money is supposed to perform – which is a store of value in the long term, a medium of exchange, and obviously, a unit of account.
I’m sure it can retain a medium of exchange because the government deems it so, because the government only accepts taxes in that particular medium, and it remains a unit of account, but that unit of account is no longer stable. The unit of account becomes very elastic. And hence, it’s quite clear to me that it’ll no longer perform the store of value.
And the chance, therefore, of some sort of breakdown in this process, where we either devolve into a deflationary environment – if, for example, people realize that the credit quality of whatever assets they are holding becomes more and more suspect, it’ll break down in a depression. Or the other way around, if people start fleeing from currency, like what happened in Venezuela recently (they started fleeing from fiat currency) , or Zimbabwe; and it has happened in Germany in the 1920s and the 30s. What is very clear then, is that that leads to a hyper-inflationary environment.
And so, at some point in time, it seems highly likely that market participants will begin to understand that the traditional forms of money or currency or whatever it is – or fiat money or fiat currency – being a unit of account, a medium of exchange, and a store of value, will start breaking down and are no longer possible. That’s when we are going to up in either a hyperinflation or some sort of a deflationary episode.
And the unfortunate bit is that we can’t say when that’s going to happen. But almost every single historical episode where central banks or governments have abused their own form of money – their own currency, so to speak – has ended up in one of these two situations (either deflation or hyper-inflation). If it’s a credit event, it ends up as deflation. If it’s an event where they continue to print money or currency and do a helicopter drop, it has almost always ended up in hyper-inflation.
The chances of either one of these two things happening are extremely high. We don’t know which one. But we do know that only gold will be able protect the investor in either of these two environments. So, as we see the monetary system becoming more and more dysfunctional, it becomes more and more important for all households or all investors to actually have that insurance in their portfolio.