Gold remains the best insurance for a crisis

As central banks race to devalue currency private individuals are hoarding record amounts of gold

The price of gold might be falling, but private individuals are buying record amounts of the precious metal, and as fears grow about the outlook for the global economy the long term attraction of gold remains.

Gold loses its shine

The strength of the US dollar and the threat from rising interest rates have made it a tough year for gold. The yellow metal was down 9pc last week to reach a five-year low at $1,083, and that marks a 43pc fall from the all-time high of $1,900 reached in 2011.

However, the fundamentals, characteristics and attractions of gold are undiminished because we remain in times of extreme intervention by governments around the world, and for thousands of years gold has been the best insurance during times of uncertainty.

Demand remains strong

This theory was proven in the latest report from the World Gold Council that showed bar and coin demand increase by 33pc during the third quarter to 295.7 tonnes, led by a 70pc year-on-year increase in Chinese investment. UK demand for owning physical bars and coins jumped 67pc to 2.5 tonnes.

Chinese demand for gold rose in the third quarter

The first rule of investment is preservation of capital. The second is to go searching for gains or income that fit with your appetite for risk. Gold has been the insurance of choice for thousands of years to satisfy the first rule, despite the fact it generates no income and actually incurs costs for storage.

US Dollar weighs on gold

It is that lack of income that is driving down the price of gold at the moment. Gold’s big rival as a store of value is the US dollar.

The market expects the US Federal Reserve to increase interest rates in December, marking the first rate increase for nine years. As the returns from holding safe haven assets such as US government bonds increase then the attractions of gold are diminished.

Bad money drives out good

One of the most interesting reasons that can be linked to the falling gold price is to be found in “Gresham’s Law” that “bad money drives out good”. The Tudor financier, Sir Thomas Gresham, found that: “When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.”

Artificial currency devaluation is nothing new. It is as old as the pyramids themselves. Sir Thomas Gresham was merely drawing conclusions from the studies of the Islamic scholar and historian, Al-Maqrizi, who noted the effect of currency devaluation during the Mamluk empire in Egypt.

Al-Maqrizi observed the effect of a liquidity crisis on the Mamluk dynasty in the early 15th century that caused money circulation to dry up. The solution was mass enforced currency devaluation through replacing the gold-and-silver-based Dinar, with copper coinage, or Fulus, and for a period the Mamluk economy recovered rapidly as trade once again flowed freely.

However, inflation soon crept in and prices ran out of control as the currency was repeatedly debased. All the while gold hoarding was taking place behind the scenes.

Fast-forward half a century, and the money printing continues apace, while demand for physical gold is rising sharply. The latest government to devalue its currency to support the slowing economy has been China.

The People’s Bank of China is cutting interest rates and allowing the value of the Yuan to fall. Chinese citizens concerned about their loss of spending power are buying gold. Gold is simply the best insurance against inflation, or deflation.

Tight supply

The other long term support to the gold price is that when prices fall below $1,000 many miners will be forced to cut output. The gold mining industry invested millions in projects that are only profitable when prices are above those levels, and it has been absolutely hammered by falling prices.

Barrick Gold, the world’s largest miner of the metal that is listed in the US, has seen its shares fall as much as 30pc this year to a 25-year low. In London Randgold Resources shares are down 10pc, and Mexican precious metals miner Fresnillo has seen its shares fall 12pc.

The smaller listed miners had an even more turbulent time. Tanzanian gold miner Acacia Mining is down 38pc; and the Russian miner Petropavlovsk, which was founded by Peter Hambro, has seen its shares collapse during the past five years.

The best insurance

The easiest way to get access to gold are through low-cost funds. Popular physical gold exchange traded funds – or ETFs – include ETFS Physical Gold (PHGP) denominated in sterling and ETFS Physical Gold (PHAU) denominated in US dollars. Also BullionVault and GoldMadeSimple, offer low-cost services where small amounts of money can be deposited, which is then backed by gold.

For those who want to own physical gold coins or bars then there are established dealers such as ATS Bullion, BullionByPost, and Chard.

Questor wouldn’t recommend buying gold mining shares, or funds that invest in miners, as it is too high risk. The first rule of investing is capital preservation. And in the face of mass currency devaluation around the world then an allocation of about 5pc in assets such as gold looks sensible.

The future is uncertain and gold is the most effective insurance against that.