You Need Gold As Insurance Against A Financial System Crash

Precious metals have had an awful period recently.

The Federal Reserve is threatening to withdraw quantitative easing (QE). That’utes been bad news for precious metals for two reasons.

Firstly, the end of cash printing removes one of the more widely-cited factors for holding precious metals. Secondly, the actual resulting strong US dollar tends to batter the commodities and precious metals sectors, because they are all by and large priced in dollars.

At MoneyWeek, we’ve moved from holding gold as an investment, in order to owning it as portfolio insurance. However is it even worth holding as insurance anymore?

I believe so, for reasons I’ll outline below. And if you’lso are a trader, now might even be considered a good time to take a little punt on gold…

The Financial System is Being Rebuilt – Hold on to Your own Insurance

As long-term readers of MoneyWeek will know, we’ng been suggesting people should own gold since the bull market took off in the early 2000s. Gold was clearly cheap. It was – not hated (as it is in some quarters now) – so much as defeated. The worst thing you could say about gold is that it wasn’t actually despised. It just wasn’t on the radar.

Of course, it increased and up through the credit bubble of the 2000s. It then peaked in late summer time 2011 at around $1,900 an oz. If there’s one thing a person could say about gold without a doubt, it was no longer cheap. This wasn’t necessarily massively overvalued either – however it was hardly off the radar. It was widely loved – and widely detested.

Later that 12 months, my colleague Merryn Somerset Webb noted that they was taking some profits on her behalf gold. Since then, we’ve seen gold as portfolio insurance, rather than a value investment. Have about 5-10% of your portfolio inside it. If everything goes horribly wrong with the global economic climate, it’ll go up. That’ll be some consolation as anything else in your portfolio goes down.

If everything goes wonderfully right with the global financial system, your gold will go down in value. But you shouldn’capital t be too bothered, since the rest of your portfolio – your Japanese stocks, your inexpensive eurozone stuff, your US-exposed UK blue chips, and all the other stuff we’ve suggested you buy – will be going up.

To cut a long story short, that’s still our look at. Insurance is insurance after just about all. You have it because you can’t forecast the future.

That said, I most likely wouldn’t feel as comfortable about having even a small holding in gold, if not for the fact that I think the threat of a nasty financial surprise remains very high. I’m keeping this insurance for a reason at the end of the day.

The global financial system is a rickety old factor. We need a new version. And en route, it’s likely to get chaotic and a bit frightening.

I’ll explain what I mean. We spent yesterday at the ” cable ” Money conference (if you don’capital t know, Wired is a glossy monthly magazine about technology. If you’re even remotely geeky – as I am – I thoroughly recommend it).

Most from the speakers were talking about ways to cut the middleman out of transactions – ‘peer-to-peer’ being the buzzword. Companies like Zopa, which enable you to definitely lend money to individuals directly, without going through a bank. Or TransferWise – a really clever currency exchange service, that lets you swap your pounds with regard to euros (or whatever) without being ripped off by banks or bureaux de change.

A lot of the help sounded great. There were lots of idealistic – but successful – entrepreneurs talking about how to make financial services which are focused on making the consumer’utes life better, rather than tearing them off in the name of boosting profits. If I was managing a bank, I’d be worried.

But what really struck me was that more and more people are asking yourself the very nature of money. A few speakers grappled with the role which trust plays in acquiring credit, or services. Others speculated on how the huge processing power we now have could feasibly make it possible to return to a barter economic climate, as trades can be so effortlessly matched to one another.

It’s not only ‘cutting edge’ thinkers. You may or may not have noticed, but there’s been a rash of publications recently, trying to explain what money is, and how it came to be.

The point is, our faith in the monetary system has been badly shaken. As a whole, our society understands that what it thought would be a solid, reliable system, is actually built on very unstable foundations and riven with special interests. We’re also realising that it doesn’t necessarily have to be like this. At some level, we’lso are groping towards a redefinition of money.

The thing is, gold has a long history of being involved in the monetary system. I’m not saying for any minute that we’ll go back to a gold standard. That system had a lot of flaws too.

But cycles tend to be messy things. So for as long as the nature of money and the financial system are being questioned as well as redesigned, I’m happy to suspend on to an object that people possess a long history of trusting because ‘money’.

A Trading Opportunity in Gold

So that’s my view on the actual long-term for gold. What about short term?

Well, I’m no investor, so I wouldn’t normally trouble bringing this up. As well as let me be clear – this is individual to holding gold as insurance. This is for someone who fancies a short-term punt that might turn a fast profit.

But in the short term at least, I’m sure my colleague John D Burford (who is a long-term gold bear) might be right in suggesting that a substantial ‘bottom’ is either in, or almost in, for gold.

You can see the piece yourself. However in short, John looked at the way in which investors are positioned in the market, and mentioned that investors were fairly much as bearish last week as they had been bullish at gold’s This year peak. So a contrarian would bet that the bears may have just about exhausted themselves.

Looking in the papers and internet over the past weekend, I’d say he’s right. Sentiment in the media is a very tricky aspect to gauge. But I think it’s fair to say that there was a ‘beargasm’ about gold at the weekend break – lots of quotes about it being in freefall, plenty of reports of ‘bloodbaths’ – even as the cost started to recover.

John Stepek
Contributing Editor, Money Morning

This post first appeared in Money Week upon 2 July, 2013