Saturday, March 15, 2014

Gold the true reserve currency?

So today, we’re in the midst of the Ukraine crisis and gold is fluctuating in value like a yoyo. Then I hear mining investor Ned Goodman on BNN stating the old story about fiat money and that only gold has real value as it is not burdened with all kinds of government debt.
The inevitable question arises, what is the value of gold then?  In theory, fiat money is backed by a country’s assets. So what are gold’s assets? O yeah, it is soooo pretty and it is soooo heavy that it breaks your back. Gold has no value and it is expensive to mine and melt into nice tiny or big shiny gold bars that you can stack up in your basement and anchor yourself to in case of flood!
As far as I am concerned, gold is useless and what it might be used for can typically also be done using much cheaper alternatives. So really…. Gold is worth nothing.
Yes, it can be used as a means of exchange, a currency that can be used for payment of goods or services. But then, that apparently can also be done with bitcoins J or… cheaper… with seashells. Finally, if all economic activity of the world was conducted using gold as a currency, the money supply would be so tight that the economy cannot function - so I think that we will always need some form of fiat money to exchange goods and services. But then not all transactions in the world are executed in U.S. dollar nominations.
The much deviled fiat currencies are backed by the assets of a country - that is until someone changes the rules. Usually it is the government, a corrupt dictator or a rebellious population that refuses to pay its IOUs, because that is basically what fiat money is. It is an ‘I owe you five minutes and 33 seconds of my time’.
All the crying about the U.S. going broke are kind of premature until the day that the dollar is no longer backed by services or goods owned by its citizens (individually or collectively). So the real risk behind owning fiat money are the politicians and the mood of a country’s citizens. In the past it were kings  or queens that could suddenly change their mind and decide that they wouldn’t repay their debts. But today it are political leaderships or when elected, their electorate that decide to default on debt.
Well when you invest in corporate debt, it is the corporate leadership that may decide to file for bankruptcy and default on its debt. So really, when it comes down to fiat money, its valuation depends on the credit worthiness of a country and on its political climate not that much different from corporate debt.
Would you invest money right now in Russian industries or Russian debt?  No way! Not with a thug such as Putin at the rudder – a man who easily occupies other countries because the world leadership is tired of fighting wars.  But that is exactly how Hitler started the 2nd world war.  That is exactly the reason that the world did go after Saddam Hussein when he invaded Kuwait during the early 1990s.  If Putin gets his hands on Crimea (Did I spell that correctly?) then like any self-respecting bully, he will not stop but he will continue taking more and more. So, unless the world can rein in this unappetizing thug now, we will likely have to confront him later in a possible more damaging situation.
Russia is currently economically weak and like Hugo Chavez' Venezuela, its only weapon is hydrocarbons. Right now, a large portion of Europe relies on oil and natural gas imports and Russia supplies about 25% of that. So, wouldn’t you be reluctant to confront Putin if your heating was coming for a large part from Russia? Strangely enough, if Obama and his reactionary environmental friends had shown a bit more foresight regarding Keystone, the U.S. and Canada would have been in a position to support Western Europe's energy needs right now and call Putin’s bluff.  LNG exports and true world oil and gas price regimes would have ruled in North America with all its benefits and disadvantages and Putin’s bite would not have been more than a fleabite.
So what does that have to do with gold and fiat currency? I guess I digressed. But is this year’s turn around in gold and gas prices not related to the Ukraine? With threats of political instability markets turn to the currency safe haven: Gold.  With shaky national economies, the confidence that governments will honor their fiat currencies has lessened. If we do go to war will national deficits rise exponentially because of the costs of financing the war machines?
I guess, gold is like any other currency with one major difference: gold is not an IOU backed by any country and there is no politician that can devaluate or revaluate the gold currency.  The ones who determine the exchange rate between gold and other currencies are the market and the Central Bank of Gold, i.e. the mining companies.  These companies in aggregate, regulate the supply and demand of gold strictly based on mining economics.
As for the price of natural gas, I have stated its bull case now for many years on this blog. Since the bottom of the gas bear market in 2012, the gas price has more than tripled. I still see a price peak in the $6 to $8 dollar range and it is probably just a year or two away. I guess, even a clock that is not running points to the right time twice a day! J 
In the meantime keep on nibbling on natural gas producers such as Peyto and CNRL (both of which I own) and sell lumbering bureaucracies such as Encana, Cenovus and Canadian Oil Sands (which I sold some time ago).
To be honest, a broken country such as Russia with Putin or a Putin-like clone at its helm is (in my opinion) more of a threat to the world than the hysterics of the European debt crisis. With gold mining companies trading near rock bottom prices and with gold now having formed a bottom, it may be time to have some of your cash in gold. With a potential war or an gradual improving economy, whichever is your fancy, precious metal and base metal companies are probably not far from their bottom or have already turned around. Having 5 to 10% of a portfolio invested in straight gold or in some of these miners is something to consider. And to answer the question in this posting's title: I don't think there is a real answer other than to state that today's reserve currency is the U.S. dollar no matter how hard the Chinese blow.  Will it be so 10 years from now? No idea and to be honest, with most investment transactions not lasting more than a few milliseconds or at worst a lasting year or so, I couldn't care less.

By the way, when mentioning stocks I do not recommend individual companies but rather I point to examples. I may or may not own such companies.  Regular readers of this blog are aware of this - the Canadian Diversified Investor blog is more geared to discussing my general investment ideas with the hope of providing, in particular starting investors, insights on how to run their own portfolios and how to build their own net worth.

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