Gold, while certainly a hallmark of John Q. Public’s portfolio, has long been characterized as a serious investment only for the doomsayers and misers among us. Considering that an investment in gold does not produce income in the same way that equity and debt does, this is entirely rational. However, it is time for gold to play more of a role in the private investor’s portfolio than simply as an inflation hedge. Put differently, inflation hedging needs to become more of a priority in the private investor’s portfolio. As an increasing number of central banks engage in quantitative easing, debt monetization, and competitive devaluation of their currency, investors in gold now will reap the benefits when everyone else wants in later.
On Sept. 13, 2012, the Federal Reserve announced QE3, the third installment of quantitative easing whereby the Fed purchases $40 billion in mortgage-backed securities each month for an indefinite period of time. All of this is in addition to Operation Twist, an ongoing Fed OMO that seeks to invert the traditional yield curve of bonds by selling short-term government debt and buying long-term. To evaluate whether or not all this liquidity will impact the money supply, it is important to determine where it is going. In these cases, QE3 and Operation Twist funds go towards banks, the primary holders of mortgage-backed securities (MBS) and treasury securities. This implies that the money base will be vastly augmented, but as to whether the money supply will be affected depends on when banks make loans – a question of when, not if. At that point in time, the ensuing inflation would erode the value of the dollar, making gold an extremely attractive investment.
Elsewhere in the world, currencies are facing the threat of devaluation through central bank activity as well. The President of the European Central Bank (ECB) Mario Draghi recently stood by the option of initiating a bond-buying program known to some as a “nuclear deterrent.” If employed, the European Monetary Union’s (EMU) money supply would eventually expand and expose the Euro to inflation as well. Although the ECB is currently unable to directly buy sovereign debt from governments, it can still provide liquidity to EMU banks. Of course, as these banks purchase sovereign debt in the same way that the Central Bank would, the outcome is effectively the same – an increase in the money supply and inflation. According to World Bank, in 2011 the US and EU comprised roughly 47% of the world economy by GDP. Thus, the central banks associated with roughly half the world’s economy are printing and injecting money into the financial system. If that isn’t a compelling case for gold, you might as well stop reading now.