The Surge of the Barbarous Relic
By
Tim Price Jun 27, 2006
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For three years we have been buying - literally - the precious metals story on the back, not so much of belief in a bull market for metals (though that also happens to be the case), but of the desire to diversify from fiat currency risk and paper assets in a world where the pace of currency production and the rise of so much sovereign and personal indebtedness seems destined to be ultimately inflationary. Zeal analyst Adam Hamilton now points to the breakout of gold prices in euro terms above €350 an ounce as perhaps 'the single most important event in this entire gold bull to date'.
Hamilton senses a good chance that private investors attracted by rising gold prices in euro terms might act as a long-awaited catalyst to force gold to decouple from the dollar bear: 'After this decoupling gold will rise in all currencies simultaneously and worldwide investment demand will grow dramatically'. It is tempting to view the resurgence of gold in both dollar and more latterly in euro terms as an alarm bell increasing in volume for the world's currency markets; as Northern Trust's Paul Kasriel recently joked, fiat currencies don't float - they just sink at different rates.
Those investors who continue to regard gold as a barbarous relic should at least be respectful of the price. In euro terms it has rallied from €335 to over €360 in the past month, perhaps fuelled by the apparent implosion of the grand European project and a crisis of confidence within the twin hearts of the Euro zone, France and Germany. Indeed, Peter Schiff of Euro Pacific Capital points out that over the last three weeks, gold has risen against all three of the world's major currencies, reaching a 14-year high of 47,800 per ounce against the yen. Schiff's suggestion is that since gold strength has come about through the weakness of the euro, the euro has started to act 'as the reserve currency of choice'.
Given the extent of speculative capital flows in a newly 'globalized' world, however, it would be dangerous to draw too many inferences from the price action in gold - just as it would be dangerous to draw too many inferences and in particular long term conclusions from the price behaviour of other assets like oil, international equities and international bonds.
But on the basis that asset markets are ultimately interlinked and must justify their valuations relative to each other - surely an argument made stronger by the rise of hedge funds, which are in many cases unconstrained at an asset class level - simultaneous strength in equities, bonds, gold and oil is baffling except inasmuch as it reflects the astonishing surge of capital into all non-cash assets.
And it is ultimately the cash market that represents the true risk-free rate, not bonds, because cash cannot provide a negative return in nominal terms. In real terms, however, cash investors throughout the world may be falling increasingly vulnerable to money illusion, in that their deposits - particularly deposits in US dollars - are being stealthily eroded by both under-reported inflation and by the loss in purchasing power consistent with the depreciation of most global currencies relative to real assets and stores of value like gold.
On the basis that valuations in financial markets globally are reflecting asset price inflation - or the natural result of vast and largely indiscriminate capital flows - the coincident strength of equities and bonds is a nonsense. If 'traditional' inflation does return with greater vigour - conventional wisdom, looking east to China and the Asian economy, seems to suggest it won't - then bond prices in particular are a nonsense given that equity markets at least offer a degree of a hedge against long term inflation.
To the sector- and stock-specific: shares in BHP Billiton, the world's largest diversified mining company, have delivered total returns over the past five years of 263%. The FTSE All Share index has delivered minus 2% for the same period. Many investors might be tempted to take profits, let alone initiate new purchases. But Billiton shares, according to Bloomberg, even after that five-year surge, only trade on a forward price earnings ratio of 13 times, which is the same as that of the All Share.
There are obviously even more potentially attractive growth opportunities in the junior mining sector - but the 'lunatic fringe' sits awkwardly for any investor, like us, driven by the principles of low risk and absolute return. In the interests of full transparency, the author is personally long BHP Billiton stock. Absent extraordinary corporate underperformance, he intends to be for some time to come.
Viewing the world through an unconstrained asset lens, a reassessment of currency exposure should be the next focus for global investors otherwise sidetracked by the rise in real assets like oil and gold. Non-dollar investors in particular should re-examine their commitment to a market like Treasuries where they stand to get burned in more ways than one.
Tim PricSenior Investment StrategisAnsbacher & Co Ltd.
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