25 January 2020
Gold is one of the best-performing asset classes. Photo: Bloomberg
Gold is one of the best-performing asset classes. Photo: Bloomberg

Ten reasons to buy gold amid deflation

As Federal Reserve chief Janet Yellen mentioned in her speech recently, the appreciation of the dollar would impose pressure on inflation and exports.

Her words imply that a strong dollar will not last for long. Without inflation growth, the rising gold price is not sustainable, while a weaker dollar would support the gold price.

There are 10 reasons why I think you should buy gold amid growing deflation pressure and uncertainty in the financial markets:

1. The value of banknotes is not reliable. According to John Williams’ Shadow Government Statistics, the dollar has lost 99.1 percent of its purchasing power since Jan. 1, 1914 when the Fed started operation.

2. Good speculation opportunity. After reaching a historical high level in September 2011, gold is currently among the few cheap assets.

3. The US dollar will become weaker as the Fed will slow the pace to raising interest rates.

4. The 2008 financial crisis exposed the issue of counterparty risk. Buying physical gold or physical gold-backed gold ETF is the only asset class that can completely avoid the counterparty risk.

5. History tells us that most governments failed to stimulate the economy contrary to what they had promised. The consequence is likely to be an unavoidable recession and a huge devaluation of currencies.

6. Gold ETF holdings have surged notably since mid-December last year, suggesting a large capital inflow.

7. Real interest rates of the major currencies have decreased significantly. It’s favorable in terms of the opportunity cost of holding gold.

8. Although the gold price peaked out in 2011 and has been on a downtrend, if we look at the period starting from Jan. 1, 2000, it has actually risen by 240 percent. Gold is one of the best performing asset classes.

9. With the negative interest rate in Europe and Japan, investors with large amounts of cash are forced to buy gold.

For example, last week, the world’s second-largest reinsurance company, Munich Re, announced it will increase gold holdings, given the negative interest rate. More are likely to join the trend.

10. The last and most excited reason: On Dec. 31, 1980, the ratio of the Dow Jones Index to gold price (per ounce) was 1.45. The right choice was to buy stocks then.

In December 2000, the ratio was 38.4, with Dow at 10,738 and gold price at US$280. It means stocks were too expensive while gold was undervalued.

The ratio today is 14.2, with Dow at 17,630 and gold price at US$1240.

I don’t know how the future trend will be like. But since 2008, the ratio has been bouncing between 7.6 and 15.1.

Even with the central banks’ unprecedented quantitative easing policies, the ratio is neither 1.4 nor 38. So, as the US stock index is currently at a high point, to make the ratio drop to 4, the gold price should be US$4,000 per ounce.

This article appeared in the Hong Kong Economic Journal on March 31.

Translation by Myssie You

[Chinese version 中文版]

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head of private banking and trust services at Hang Seng Bank