Gold the other currency- The importance of gold in investment portfolio C.A. Shubha Ganesh "We have gold because we cannot trust governments." said President Herbert Hoover's statement to Franklin D. Roosevelt in 1933 1
A fascination that has Lasted 5,000 Years For 5,000 years, gold's combination of luster, malleability, density and scarcity has captivated humankind like no other metal History In early era gold was used in coinage Around 700 B.C., gold was made into coins for the first time Copper, silver and gold formed three tiers of coins Gold coins were used for large purchases, payment of the military and backing of state activities Silver coins were used for mid sized transactions, and as a unit of account for taxes, dues and contracts Copper coins represented the coinage of common transaction 2
Control over volume Issue of physical coins kept a control over volume in circulation Actual gold required Transfer and transportation was difficult Defacing, chipping, and reduction in value due to transfers Countries needed to hold large gold reserves in order to keep up with the volatile nature of supply and demand for currency License to make money During both the coinage and credit money eras the number of entities which had the ability to coin or print money was quite large One could, literally, have "a license to print money"; Many nobles had the right of coinage. Royal colonial companies, such as British East India Company 3
Parallel paper money Europe's introduced paper in the 16th century with the use of debt instruments issued by private parties Between 1696 and 1812, the development and formalization of the gold standard began as the introduction of paper money posed problems Gold standard The gold standard is a monetary system in which paper money is freely convertible into a fixed amount of gold 4
The Rise of the Gold Standard By 1821, England became the first country to officially adopt a gold standard The international gold standard emerged in 1871 following the adoption of it by Germany From 1871 to 1914, the gold standard was at its pinnacle but this all changed forever with the outbreak of the Great War in 1914 The Fall of the Gold Standard In 1931, the gold standard in England was suspended, leaving only the U.S. and France with large gold reserves Then in 1934, the U.S. government revalued gold from $20.67/oz to $35.00/oz This higher price for gold increased the conversion of gold into U.S. dollars effectively allowing the U.S. to corner the gold market 5
Gold Reserve Act 1934 U.S dollar gained momentum as an international reserve currency that was linked to the price of gold The Gold reserve Act of1934 gave the government the power to peg the value of the dollar to gold and adjust it as it pleased Bretton Wood Agreement The Bretton Woods Agreement was developed at the United Nations Monetary and Financial Conference held in Bretton Woods, in 1944 Brenton woods permanently fixed the U.S. dollar at $35 per ounce At the end of WWII, the U.S. had 75% of the world's monetary gold, and the dollar was the only currency still backed directly by gold 6
Gold no more This successor system was initially successful, but because it also depended heavily on gold reserves It was abandoned in 1971 when U.S President Nixon "closed the gold window" The growth of paper At one time, there was enough gold for all of the currency in circulation From 18th century that paper money began to dominate Due to the global expansion that took place after the war, bank reserves did not hold enough gold reserves to back the growth of the currency, which was needed to finance the global expansion further. Paper currencies and printing presses took over 7
Money with wings Money's value was now decided purely by its purchasing power It became possible to create more money than there was gold to back it Set the stage for inflationary money policies where the government could print more money Additional money caused the purchasing power of each dollar to drop because there was nothing backing it Critique Perhaps his16tory demonstrates that it is just too difficult for the world to work under a monetary standard based on a commodity When these metals were used as monetary standards, the divergence of the market price and mint price for these metals seemed to be in continual flux Arbitrage opportunities between market and mint prices created havoc on economies. 8
How do we view gold now Can gold still be considered as currency? Is it now just a commodity? Or can it be called as an asset class? Is gold an insurance or a hedge? Factors influencing gold prices Supply and demand 9
Demand The price of gold tracks the shifting balance of supply and demand Long lead times in gold mining mean production of gold is relatively inelastic regardless of increases in demand About 2,000 tonnes goes into jewellery or industrial/dental production, and around 500 tonnes goes to retail investors and exchange traded gold funds Investment Demand A significant portion of investment demand is transacted in the over-the-counter market, therefore not easily measurable Since 2003, investment has represented the strongest source of growth in demand. In 2009 alone, investment attracted net inflows of approximately US$41bn 10
Technological demand Industrial, medical and dental technology accounts for around 12% of gold demand (an annual average of over 434 tonnes from 2005 to 2009) thermal and electrical conductivity medical applications Demand Flows 11
Supply Mine production Today, the overall level of global mine production is relatively stable. Supply has averaged approximately 2,497 tonnes per year over the last several years The stability of production comes from the fact that when new mines are developed, they re mostly serving to replace current production, rather than expanding global production levels. 12
Recycled gold While gold mine production is relatively inelastic, recycled gold ensures there is a potential source of easily traded supply when needed This helps to cater for an increase in demand and keep the gold price stable. Between 2005 and 2009, recycled gold contributed an average 32% to annual supply flows Central Bank In 2009 central banks had of 28,900 metric tonnes nearly 25% of all the gold ever mined In other words, there is enough gold in the vaults of central banks to satisfy world demand for 10 years without another ounce being mined! What other commodity has this kind of demand/supply imbalance? 13
Top fifteen holdings of gold as on June 2010 14
Stocks as on 2009 Supply Flows 15
Discussion Can we now say gold is just a commodity subject to demand supply dynamics? Gold as an asset class The demand and supply dynamics of the gold market underpins the precious metal s extensive appeal and functionality, including its characteristics as an investment vehicle 16