Can gold give you shelter from the perfect storm?

Equities and gold traditionally fare best during inflationary cycles, and the question is when, not if, inflation will emerge again. Current economic wisdom is that fuelling inflation is acceptable to kick-start economies again. So far expats have mainly seen the downsides of monetary policy implementation, ranging from negligible saving rates to home currency devaluations and pension income dilution.

This month we've looked at the various ways economies can either react to, or interact with, equity markets and how additional factors can affect your nest egg. It makes sense for all expats to first create and then protect the wealth that they have accumulated for their future.

Many expats remain abroad for their entire lives and are thus required, out of necessity, to build sufficient reserves to sustain themselves. Wealth protection is often something that they choose to oversee themselves. But such control can be viewed as dangerous when left entirely in your own hands; thus the need for strict and prudent management is essential for success.

It is also true that there are more perceived advantages to having control of your own asset pool because you are more likely to be involved in the decisions of how management is carried out. As an expat you are privileged to have access to a greater variety of investment options than those left behind at home.

Since the 2008-2009 recession an increasing number of large pension schemes from all over the world have realised they are going to run out of resources to meet future benefit requirements.

This means that if you have a home-based pension, you may be disappointed if your scheme is one that goes broke in the future. While many people sit back and think "it will never happen to me" this whole experience is something that is becoming more and more widespread among both the small and large pension administrators.

Pension funds invest in various market sectors but usually a high portion of assets are tilted toward equities. This means that they have suffered a great deal over the past few years because they have been paying benefits from reduced overall investment values, depleting reserves. Now many schemes are so far behind that they will never catch up.

If you had a personal nest egg which had declined in recent years and you left it invested, by now you would have caught up again and be moving ahead. If you were drawing from your nest egg then perhaps you would have been wise to have divested out of equities.

Last week I looked at two periods in the US _ October, 2007, and now _ when the Dow Jones Industrial Average topped 14,000 points, and the differences in the overall situation at each of these time points, including economic and market factors. It follows from that little study that there seems to be no clear direction we are headed in, and it is a tricky matter to make decisive moves with an investment portfolio that will secure definite ongoing protection.

One area that deserves consideration is precious metals, particularly gold. We all know that gold is a subjective investment. Looking at the history of this elemental substance reveals volatile movements in its value over the years. However, when you actually compare it against almost any currency it has grown in value. Gold tends to be a hedge against inflation.

Now let's turn to "fiat currency" _ the issuance of legal tender, a longstanding tradition of many civilisations. Rome initiated coinage nearly 2,000 years ago which was pure silver. Some 40 years later it was deemed that coins of 94% silver were permissible, and after a further 200 years 43% silver was acceptable. This is devaluation in its simplest form.

In the 11th century, China started to issue paper money and after a long, drawn-out series of events, the paper was almost worthless by the time Marco Polo came on the scene in the late 13th century.

John Law introduced paper money to France in the reign of Louis XIV. By the time Louis XV was in power paper money was worthless and precious metal coinage was the demanded method of payment of the day.

There is a litany of similar events in Germany, Mexico, Argentina, Russia and elsewhere. Many readers will remember the currency crisis of 1997 when the Thai baht collapsed and a domino effect was created with neighbouring countries where devaluations of currency also took place.

Many countries have learned the dangers inherent in paper currency and its possibilities for manipulation.

In 1933, US president Franklin Roosevelt decreed that it was illegal to own gold coins exceeding US$100 in value. This led, in effect, to a licence to print paper money in any amount.

In 1971, president Richard Nixon made several plays linking the dollar to the value of gold. This meant that as more dollars were printed they had less value because it was based on overall gold reserves. Thus the ensuing decade of the 1970s and part of the 1980s saw massive inflation and economies spiralling out of control.

If you're thinking these events have similarities with the situation today, you're right. Printing presses are overheating, but the reserves that back those currencies are not gaining any value.

Equity investors are totally sanguine, and buying more and more at the present time. The herd mentality has taken over once again. But are equities safe? The long term could prove interesting. If we dive into a period of extended inflation, equities may do well if you do not need to draw down on the capital values. Dividends will correlate somewhat with inflation and give some income from the investments with partial inflation protection.

Right now many countries, including the US and UK, are telling us that they are trying to double inflation to something like 2% annually. However, are we shown a cloudy picture of current rates by statistical manipulation? Is it possible that real inflation is actually 3% or more already? Statistics reveal that take-home pay in the US actually has less real purchasing power than in the 1960s and 1970s. There are also claims that inflation, employment, GDP and retail sales figures are being manipulated before they are published.

Financial institutions apparently bet on the future price of gold and short the market to keep the price down. If they fail, the printing of further paper dollars covers the losses. If this is the case, once it is all revealed it will bring on a perfect storm from which there may be no escape.

It may be that 2008 was just a prelude to what's to come, and the situation is now even further out of control.

In light of these considerations, would you be wise to invest in gold? Perhaps physical holding funds are the best. Some funds invest in gold miners and producers. These could also be of value. One of the most difficult things to decide here is when to make a move, if you decide that this is the way forward.

As ever, it is best not to panic but to think situations through carefully. Should you follow the optimistic crowd or be a contrarian? You may make a fortune; but alternatively you could make a wrong move and allow your portfolio to slip in value.

These decisions are not easily made. If anyone claims to know with certainty what will happen in any market in the future, he or she is dreaming. However, a professional adviser can assist you in your thinking and evaluation.


Andrew Wood has been an expat in Asia for 33 years and is executive director of PFS International. His articles, which cover the complete A-Z of financial planning, are available through the PFS library to readers on request. Questions to the author can be directed to PFS International on 02-653-1971 or emailed to enquiriesthailand@fsplatinum.com.

About the author

columnist
Writer: Andrew Wood
Position: Writer