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OPINION

Is exposure to bullion preferable to cash?

Is exposure to bullion preferable to cash?
October 21, 2020
Is exposure to bullion preferable to cash?

The timing of the updates may be opportune given that the Bank of England (BoE) has been drip-feeding the market on the prospect of negative interest rates. A key consideration, one would imagine, not only for gold producers, but also for those investors who are holding a higher proportion of cash than they might under normal circumstances.

Even if we disregard the proposition that real interest rates are already in negative territory, at least when you factor in the impact of the Consumer Prices Index (CPI), the increased physical premiums we are now seeing on bullion trades could point to rising anxieties over currency debasement. (Admittedly, sceptics might also point to the impact of the Indian wedding season – dowry time – which takes place between Oct-Dec.)

Of course, we have been here before. There were innumerable articles on the prospect of runaway inflation in the wake of the global financial crisis, once central banks had responded through unprecedented quantitative easing programmes.

They have done much the same thing in response to the Covid-19 lockdowns, but there is a crucial difference this time around. The capital now being pumped into economies is finding its way into peoples’ pockets, rather than simply bolstering the balance sheets of the banks and other financial institutions.

This colossal recapitalisation did not come with any obligation to increase borrowing to the ‘real economy’, so few central banks had to contend with a steep rise in the money supply. (I was going to write “the volume of notes and coins in circulation”, but that is something of a red herring nowadays.)

The CPI moved up to 0.5 per cent last month, more than double that of the historically low rate recorded in August, with the rise almost entirely due to rising transport costs and an increase in the cost of eating out once the government’s support scheme was pulled.

Obviously, this does not suggest that we are in 1930s Weimar Germany, and the BoE’s Monetary Policy Committee is reasonably confident that the UK economy will remain well within the 2.0 per cent inflation target rate for the foreseeable future. But it is difficult to imagine that the government will not allow inflation to eat away at its debt mountain once a degree of normality returns to the economy.

A prolonged tax raid is probably nailed-on by now, yet it is debatable whether this will prove sufficient to meet the government’s increased financial obligations now that public debt exceeds gross domestic product. Another option is the reimposition of so-called ‘austerity programmes’ – the description, always something of a misnomer given that central bank borrowing continued to crank-up despite the measures. This would not only be politically unpopular, but it is somewhat at odds with the implicit fiscal strategy of Boris Johnson’s administration. At any rate, we could see the BoE and other central banks taking a less hawkish line on inflation rates over the long run.

A combination of moribund interest rates and rising inflation would be favourable for precious metals miners, though the debate rages as to the preferable option for gaining exposure to precious metals, whether through equity, derivatives or bullion.

Given the growth of physically-backed exchange traded commodities (ETCs) in recent years, it is not surprising that the debate over their suitability from a precious metals standpoint often revolves around correlation versus causation. More importantly, investors need to remember that most issuers are also often exposed to the ups and downs of global securities markets, creating an additional source of risk, while most custodians' insurance does not cover the value of all the metal they hold in custody, so it is not quite the same as having a stash of Krugerrands under the floorboards.

A rather threadbare point, though one always worth repeating, is that while market valuations for precious metals stocks may occasionally correlate with the price of the underlying metal, they are largely determined by the expected future earnings of the company, not just on the value of the spot price.

Nevertheless, unless you are adding to your bullion holdings in expectation of a significant prolonged reduction in purchasing power brought about by currency debasement, gold-mining stocks may be a preferable option for those investors looking to play the ongoing rally.