The Ultimate Anti-Dollar Investment

I’m what people call a “contrarian” investor. I tend to buy assets that are out of favor with the chattering classes and the talking heads on television.

And I make it a point to sell when the “man in the street” starts giving me investment tips. That happened most recently in 2011, when over a glass of Malbec at a local watering hole, I overheard two other patrons talking about the “killing” they were about to make buying gold at $1,800 an ounce. I sold all but my core position the next day.

Since then, gold has had a tough time of it. It closed last week under $1,100 per ounce. The talking heads now predict $800 gold by the end of 2016.

I don’t agree, but I understand their logic. After all,

• The US dollar is on a tear. Many investors purchase gold to guard against dollar devaluation. But the US Dollar Index, a weighted average of the dollar’s value against a basket of currencies, stands near its highest level (reached in March) since 2003. In the last year alone, this index has soared over 15%.
• Digital currencies like Bitcoin are eating away at gold’s popularity. No, digital currencies aren’t backed by a commodity, but they’re not created out of thin air by a central bank either. And their ease of use and potential for anonymous financial transactions has reduced some of gold’s traditional allure.
• Chinese consumers are selling. While it’s not received much attention in the US, Chinese stocks have cratered, dropping 30% in the last month. This drop comes on the heels of a stunning 154% gain between June 2014 and June 2015. As is often the case in roaring bull markets, many first-time stock investors used money they couldn’t afford to lose, to invest. Some of them even borrowed money to make leveraged bets. Those that borrowed money must now repay their loans with whatever asset is easiest to liquidate. In many cases, that’s gold. 
• Unprecedented appetite for high-risk investments.Who needs gold when you can get rich buying a startup company? While gold hit a 5½ year low last week, during the last quarter, venture capital (VC) companies invested the most money in high-risk startups since the heyday of the Internet boom in 2000. Back then, VC moguls were investing millions in questionable holdings such as WorldCom, Pets.com, and Baby Bob, all of which eventually declared bankruptcy. I suspect we’ll see a lot more bankruptcies when this VC frenzy ends as well.

Under the circumstances, it’s easy to see why the talking heads see only disaster ahead for gold. But I think they’re missing the point.

That’s because gold is the ultimate “anti-dollar” investment. Despite its current strength, the dollar priced in gold has lost more than 95% of its value in the last 100 years. During that period, gold prices have increased more than 50-fold in dollar terms – from an official price of $20.67/oz. in 1915 to nearly $1,100/oz. today.

It’s also telling to observe that central banks, the folks who simply create dollars or euros out of thin air, are net buyers of gold. Indeed, as a group, the world’s central banks are buying more gold than they have in more than a half a century.

Obviously, central banks aren’t listening to the talking heads. But why are they buying gold? The only plausible reason is to hedge against a decline in value of the other assets they hold, primarily US dollars. Indeed, fully 60% of disclosed central bank reserves consist of US dollar holdings.

Central bankers understand that if the dollar takes a hit, the value of their reserves will fall sharply, unless they also hold assets that will appreciate as the dollar falls. That’s exactly what gold has done for more than a century. Indeed, gold has a 5,000-year track record as the ultimate asset to hold against debasement of a nation’s currency.

Unfortunately, it’s not at all clear how much gold central banks are buying. For instance, China announced two weeks ago that its official gold holdings now come to 1,658 tons. That’s only a fraction of what many analysts thought they had stockpiled. The small size of China’s hoard gave the talking heads yet another reason to recommend selling gold.

Yet, the Chinese might have lied about this statistic to depress the gold market further. After all, if you have a long-term strategy of accumulating a particular asset, the last thing you want to do is telegraph your intentions to others. They’ll just bid up its price, forcing you to pay more.

China is the world’s largest gold producer, mining more than 2,000 tons of gold since 2009. It’s imported at least another 4,000 tons of gold as well in this period. Chinese consumers no doubt purchased some of that gold, but I suspect a big chunk of it is sitting in the vaults of the People’s Bank of China. I think China has a lot more than 1,658 tons stockpiled.

Sure, gold could go lower. In any financial crisis, for instance, debtors must liquidate their assets to pay creditors. Since gold is a highly liquid asset, it’s easy for debtors to sell it to raise cash.

Still, gold is the cornerstone of my own portfolio. As the anti-dollar, when the dollar finally corrects – and it will – gold prices will recover, and the dollar will resume its 100-year plunge in value.

And that’s far from the only reason to buy gold. Unlike bank accounts, governments can’t “bail in” gold. If your gold is held securely in allocated form, it has far more intrinsic safety than a bank account deposit, a money market holding, or a promise to pay issued by any government.

There couldn’t be a better time to start buying gold – especially if you don’t already own some – than now.

Reprinted with permission from Nestmann.com.