Don't be a Hero - own some Gold

A case for gold now

Last week, Gold & Bitcoin made lifetime highs with bitcoin scaling to $69,000 and gold hitting $2126 per ounce.

The Bitcoin rally this time seems very different. Not many people have laser eyes in their profile pictures, phrases like WAGMI, having fun staying poor, etc have all gone out of fashion. Maybe it’s because the main actors who fuelled the last bubble are all under regulatory scrutiny. Maybe it’s because all the VCs have pivoted to AI.

Price action however remains as volatile as ever. After making all-time highs, Bitcoin puked 10% the very next day. By the time you read this, it might even be trading below $10k or above 100k.

Gold on the other hand is holding steady and could be making more highs this year.

Americans have set a new precedent

Once the war in Ukraine broke out, the Western powers led by their dad, America, sanctioned Russia. Sanctions are nothing new, India was sanctioned in 1998 after its nuclear tests. Iran and Venezuela have been under sanctions for years.

In Russia's case however, NATO & allies seized $300 billion in assets of the Russian central bank. They also cut off Russia from SWIFT, the international banking rails for money transfers. This is a big deal, as it cut off Russia from operating in the Dollar system.

“The illegitimate freezing of some of the currency reserves of the Bank of Russia marks the end of the reliability of so-called first-class assets. In fact, the US and the EU have defaulted on their obligations to Russia. Now everybody knows that financial reserves can simply be stolen. And many countries in the immediate future may begin – I am sure this is what will happen – to convert their paper and digital assets into real reserves of raw materials, land, food, gold and other real assets which will only result in more shortages in these markets.” - Vladimir Putin, March 2022

What NATO and its allies see as sanctions, Russia sees it as a default. The “international rule-based order” was violated. All non-western powers noticed how the dollar reserves of a central bank were no longer sacrosanct.

Central banks around the world are buying gold

If a central bank’s dollar reserves can be sanctioned, the central bank better diversify and own more Gold. The Chinese seem to have taken notice.

“This adds to the evidence that the US is no longer a safe place to store reserves. If the US abuses its position to use sanctions as a geopolitical tool against rivals, it will be the death knell for its financial hegemony. Sanctions on Russia's financial system, such as the freezing of the central bank's reserves, will probably become a turning-point for US financial hegemony.” - Global Times, Chinese state affiliated media in March 2022.

China has backed this talk with action. They have their reasons to diversify away from the US.

Many other central banks worldwide have also aggressively bought gold over the past 2 years. India and Turkey have been significant buyers of gold with India’s reserves increasing by 50 tonnes over the last 2 years.

While this is significant buying, it is still early days. Gold as a percentage of central bank reserves is still in single digits for all BRICS members outside Russia.

Central banks will likely continue to diversify reserves away from the dollar and keep buying Gold in the long run. There are valid reasons to do so.

America is running huge deficits

Needless to say, I am not an economist, so I will keep this short. Despite having 3.3% GDP growth and record-low unemployment, the US government is in enormous debt. The fiscal response to the pandemic and the inflation shock of 2021 have both been to print more dollars, with a view that deficits don’t matter.

Budget deficits now routinely run over a trillion dollars. This is not a problem until one day it is. There is a real risk that inflation will come back.

Gold is as good as Nifty

A common complaint I hear from people is that while gold offers protection in bad times, it generates low returns in the long run.

Since the start of this century, Nifty has generated 11.7% CAGR, and Gold has appreciated at 11.4% CAGR. Including dividends, Nifty has returned 14% during the same period. A 2.6% delta over 23 years makes a significant difference. But it’s hard to argue that gold has been far behind.

Interestingly, the entire alpha of owning Nifty has come from companies returning capital to shareholders and not from the underlying growth in business value. Only if owning gold could return some capital to investors! RBI has been issuing SGB since 2015, with yields of 2.75% making gold ownership even more attractive.

It’s not just that the returns are similar, gold has generated the same returns with significantly less volatility. When the financial world was in an existential crisis in 2008, Nifty investors lost 54% and the gold bugs made 30% for the year.

Because it’s less volatile and generates returns during bad times, a combination of equities and gold should do better than just owning equities. A portfolio of 80% Nifty and 20% gold rebalanced on the 1st of every year, consistently outperforms Nifty.

It is unclear if most people know, understand, or have internalized this data. The risk premium for owning equities should be far higher than the prevailing levels in India.

20th Century’s greatest investor disagrees

Warren Buffett has never been a big fan of gold. Over the years he has made this pretty clear.

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head” - Buffett

Gold is indeed mostly unproductive but it is Lindy. Currencies, kings, and nation-states have come and gone, but gold has been around for thousands of years as a store of value and a medium of exchange.

Plus it’s important to remember that none of us are Warren Buffett.

Can we own proxies?

The closest proxy to owning gold is buying Gold assets. Gold miners are like any other mining business which have their idiosyncratic risks.

It doesn’t always work, like now and you can never be certain that the business will track the returns of the underlying commodity.

And no, owning jewelry companies is not a proxy for gold. While jewelers have some inventory gains when gold goes up, it dampens demand and impacts margin in the long run.

Final thoughts

The world is now more connected than ever. Pandemics, wars, and financial shocks can all travel more quickly than at any time in history.

Owning gold is the only proven, reliable way to hedge the unknown unknown. Even if you are a seasoned investor, it is logical to have some insurance in the form of gold.

Don’t be a hero, own some gold. And remember that your family jewelry doesn’t count.

Disclaimer: Nothing written here is investment advice.