“Successful investing is about managing risk, not avoiding it.”
– Benjamin Graham
October 28, 2024—Eight days remain until Election Day. In Grey Swan terms, a week from now, there’s a highly predictable chance the media will be examining state-run ballot systems, the Electoral College and the political makeup of the Supreme Court.
These crises can result in hard times for the market. The S&P 500 ended the year 2000 down 9%, following an election where the swing state of Florida was decided by 537 votes (or 5 to 4 if you think the Supreme Court’s decision to order the recount stopped).
Stocks then fell 12% in 2001, and another 22% in 2002. That adds up to a decline of over 42%. The dotcom-heavy Nasdaq fell 78% peak-to-trough over those years, which also coincided with the Grey Swan of the dotcom bust and the horrific 9/11 attacks.
Going back to the constitutional crisis of the 1970s, when Nixon abdicated the presidency, markets tanked 50%, and inflation soared to double-digit levels. Saudi Arabia proved it could throttle the US economy. Oil supply dwindled. There was a legitimate crisis of confidence in the U.S. Government.
With confidence evaporating in the same institutions, including the media, today, it’s not much of a stretch to imagine another chaotic unfolding of events starting next Tuesday, Nov. 5. (You can see our full research on the possibility of how an election crisis could unfold in 2024 here: The Grey Swan Election Nightmare Scenario.)
The only thing we do know for sure, is no matter who occupies the White House in January, both parties promise big spending plans.
The Committee for a Responsible Federal Budget (a group that sounds like a hit at the parties we like to throw) put Harris’ plans at 26.2% of GDP being spent by Uncle Sam, with Trump spending “just” 25.7%.
Even if neither budget comes to pass, by 2035, the Feds will eat up one out of every four dollars in the economy.
The vibe election is only about who gets to spend it and on what.
Fundamentally, however, government cannot spend any money… without taking it from you first, or issuing new debt or inflating away the currency.
Banks, traders and bureaucrats love the system, as is.
There are alternatives.
We reviewed our position on Bitcoin Friday. Today, we look at gold.
Much like stocks, gold has been on a tear this year. It’s slightly edged out the S&P 500, likely due to strong central bank buying and an increase in market liquidity over the past few weeks.
Debt matters. One way to protect yourself in a debt crisis is gold. Looking further at the implications of gold as it tops $2,700 per ounce, and what investors should do from here, is Rob Marstrand. Enjoy – Addison
Gold Punches Above $2,700. Too Far, Too Fast?
Rob Marstrand, OfWealth by Rob Marstrand
The first time that I invested in gold was back in 2003 or 2004. This was after I’d been posted to Hong Kong, to work on the regional strategy for my employer at the time (UBS Group, the global wealth manager and investment bank).
If memory serves, I’d read a couple of papers about gold’s long-term role as a value preserver, and also about how government debts — which are nothing more than the aggregate amount of past fiscal deficits — were having progressively less incremental impact on propping up GDP growth.
It seems bizarre now, given all that’s gone on over the past two decades, and the explosion of government debts since the 2007-2009 Global Financial Crisis. But I was already starting to get concerned about unsustainable government finances. Gold seemed like a good hedge, so I decided to dip my first toe into the gold market.
My first investment, as a naive gold newbie, was a gold-linked bank deposit via my local bank account in Hong Kong. Mainly because it was very easy to do.
As I researched gold investment further, I soon realised that this was one of the least safe ways to get investment exposure to gold. That’s because it relies on the solvency of the bank. Any gold reserves that the bank might own are “unallocated”, meaning not the property of the gold-linked deposit customers, such as myself.
Once I had worked this out, I looked for a safer way to own gold than gold-linked bank deposits. The Global Financial Crisis that started in 2007, when vast numbers of supposedly-safe banks went under and had to be rescued (or were allowed to fail – see Iceland), later rammed home why this is essential.
The choices for gold investment were thinner on the ground back then, involving such things as Perth Mint Certificates from Australia, or actively-managed gold mining funds with high fees. The very first gold exchange-traded fund (ETF) was launched in Australia in 2003, and the first U.S. gold-backed ETF was launched in 2004, the SPDR Gold Shares ETF (NYSE: GLD). Gold ETFs made investing in gold as easy as buying any other share via a brokerage account.
By 2005, a London-based online bullion service called BullionVault had started up, and I think I was a fairly early customer (either late 2005 or early 2006, if memory serves). BullionVault offered a cheap and safe way to invest in large gold bullion bars (or part bars), stored in a choice of secure vaults in various cities (at the time in Zurich, London or New York).
You could (and can) buy and sell via a trading page on the website, making it very easy and convenient. At some point along the way (2010? 2011?) I met BullionVault’s founder and CEO, and this only improved my impression of the service.
BullionVault was a pioneer. That’s because before it existed private investors had to buy whole bars and pay a lot for storage and insurance, leaving bullion investing restricted to only the wealthiest.
There were copycat services launched later, especially in the U.S. But, unless something has changed radically in recent years, those were far more expensive than BullionVault in practically every scenario. That was due to significantly worse pricing when buying and selling metal, and/or much higher trading commissions, and/or higher custody fees to store the gold.
Of course, before such services (or the ETFs) there were always gold bullion coins, such as South African Krugerrands, American Eagles, British Sovereigns, etc. In my opinion, these should only ever be bought and collected in-person from reputable coin dealers with long histories. They should never be bought remotely from newer firms that send merchandise by post, unless you like the high risk of being scammed.
But bullion coins were (and are) only suitable for very long-term holdings. This is because the spreads between purchase and sales prices are so wide, to cover dealers’ costs and leave them a profit. Also, coins are no good for very large investments, given the practical challenges of storing big coin caches in a safe way. Allocated bullion, insured and stored in a secure vault, is the best way to own a lot of gold.
Anyway, back to my first steps into gold in the early 2000s. I remember talking with a very senior investment bank colleague about gold, and him dismissing it since it earned no income yield (paid no interest coupon or dividend). This was a very common attitude at the time, and still is today for that matter.
Scepticism towards gold was rife at the time. This was perhaps no surprise, since gold was in a grinding bear market after a speculative market episode in 1980, followed by a big, long, drawn-out flop all the way until 2001.
Famously, in 1999 the UK’s Chancellor of the Exchequer (translation: finance minister), a fellow called Gordon Brown, pre-announced that the Bank of England would sell half of its gold reserves.
This caused the already-depressed gold price to plunge further, bottoming out at $252.80 per troy ounce on 20 July 1999. The dark, gallows humour of professional traders labelled this trouser-tightening market moment as “the Brown bottom.”
Gold stayed depressed until 2001, as the Bank of England worked through its sales. Things finally started to turn around in 2002, and gold has largely been in a monumental bull market ever since, although with some setbacks along the way.
Incidentally, part of the driver was that China permitted its citizens to own gold again after 2004 (if memory serves), having banned it after the communist revolution in 1949. This is an important fact that is often overlooked. China’s huge population combined with its extremely rapid economic growth over the past two decades – and the huge numbers of very rich people that resulted – were important drivers for the gold price.
The fact that I first invested in gold at around the same time as it was allowed again in mainland China was a complete coincidence. But, with hindsight, it has undoubtedly been my most successful play on China’s economic ascent.
The Long Bull Market
At the time of writing, the dollar gold price is $2,738 per troy ounce. That’s up 10.8 times since 1999’s Brown bottom, in the space of a little more than 25 years. It’s equivalent to an average, compound rate of return of 9.9% a year.
According to official data, US consumer price inflation amounted to 89.7% over the same time period. That works out at a compound average of 2.6% a year. Put another way, gold investments made about 7.3% a year real (above-inflation) returns since July 1999, on average and in US dollar terms.
Of course, many people believe that official inflation figures are understated, including me. This is mainly due to statistical tricks known as “substitution” and “hedonic quality adjustments.”
(Substitution involves putting cheaper products in the inflation basket when prices rise – e.g. more chicken, less beef. Hedonic quality adjustments involve artificially adjusting prices down due to supposed improvements in product quality. For example, the same car model may have gone up in price substantially over time. But if it contains more tech or safety features than before then the inflationary effect is reduced or removed, as the buyer is deemed to have got more for their money. Never mind that its main function – getting from A to B – has not improved, and that more basic models may no longer be available.)
My best guess is that actual price rises are about one percentage point a year higher than official inflation statistics, and perhaps a little more than that. Even under that assumption, gold has delivered a substantial real return over the past 25 years.
I’ve stayed invested in gold ever since my first toe dipping in the early 2000s, to a greater or lesser extent. Sometimes I’ve owned a bit more gold, sometimes a bit less. But it’s always been there, and I’ve learnt a lot more about gold – and precious metals in general – along the way.
During the period of the Global Financial Crisis, I think that my allocation to bullion peaked at around 50% of my financial assets (made up of bank deposits and investments).
That’s far higher than I would usually want, or recommend. But it was an extreme moment when gold’s value as crisis insurance really became valuable, before we knew whether the banks would really be saved. More normally, and allocation of somewhere between 10% and 25% is reasonable.
Along the way, I’ve read a lot about gold, and thought a lot about its purpose as an investment. The main reasons I like owning it are the following four things:
- The main use of gold is as jewellery. The main gold-buying nations are China and India, which have deep cultural affinities for gold. Both have huge populations that are becoming steadily wealthier over time. Wealthier people buy more gold jewellery, on average. Meanwhile the global stock of gold only grows very slowly, and it is harder and ever more expensive to mine new gold. The global population continues to grow too. This combination of growing demand (more people with more money) and relatively fixed gold supply provides a long-term tail wind for the gold price. Over the ultra-long term, gold has preserved its value in inflation-adjusted terms. But if these huge countries (and others) continue to grow, gold seems likely to outperform inflation, on average, in coming decades.
- Gold is a hedge against financial crises and a safe haven during periods of uncertainty, and there is no shortage of potential crises. Most developed country governments are effectively bankrupt and continuing to run up even bigger debts, along with printing money in vast quantities (e.g. GFC, Covid). The result will eventually be sovereign crises, with collapsing currencies and/or bond markets. Gold provides a haven from such situations.
- Even more severe crises are possible, of a geopolitical nature. The Russian invasion of Ukraine surprised most people, and the war still has potential to expand if bad decisions are made by one side or the other. (I recently read that North Korean special forces are now in Russia.) Israel’s conflicts with Hamas and Hezbollah terrorists, and their sponsor country Iran, could expand (with implications for oil and gas markets). China still has its eyes on Taiwan, and recently carried out naval drills close to the island. Chinese President Xi Jinping is 71 years old, meaning he is running out of time to achieve reunification within his lifetime, something that would place him close to Chairman Mao Zedong in the pantheon of Chinese communist leaders. In such a scenario as Chinese invasion of Taiwan, there is potential for North Korea to launch a simultaneous attack on South Korea, in order to spread US / allied forces more thinly in the region.
- Although my favourite asset class by far is stocks, I like to have at least some diversification into other areas. Aside from short-term cash balances, ready to invest when prices are attractive, the other main alternatives are bonds and gold. Since I don’t like lending to bankrupt borrowers with mediocre leadership (or worse) – which means most developed countries and their governments – this makes gold the default main option for portfolio diversification.
Thus, I think there are plenty of good reasons to own gold, as an asset that’s likely to appreciate over the long term, as a crisis hedge, and as a general portfolio diversifier.
But boy oh boy, it’s gone up a lot recently. Not that I’m complaining. But such big moves always make me question whether I should keep holding something. Or, at least, whether I should be trimming the position and taking some profit…
To keep reading Rob’s idea on Substack, click here. ~~ Rob Marstrand, ofWealth by Rob Marstrand
So it goes,
Addison Wiggin,
Grey Swan
P.S. Phil Lesh, one of the founding members of the Grateful Dead, died on Friday peacefully at the age 84.
“Phil brought immense joy to everyone around him,” his family commented, “and leaves behind a legacy of music and love.”
We learned everything we need to know about a free market traveling among the legions of Deadheads who followed the Grateful Dead in the 1980s. The counter-culture that thrived on the road, then and in parody form now, is reminiscent to our fraternity of Grey Swan thinkers and spenders.
As always, please send your thoughts, whether on the dollar, gold, bitcoin, or being a Deadhead to: addison@greyswanfraternity.com
