Physical gold becoming a strategic asset

During 2020 gold performance has been spectacular, rising roughly 25% over the last year, outshining nearly every other asset class. The yellow metal in fact, crossed US$2,000 an ounce level for the very first time in August 2020. While gold price has since retreated, a bull market does appear to be well intact.  After years of consolidation gold is once again turning heads and raising important questions for investors.

Recent price movement certainly reflects the traditional catalysts and positives underlying fundamentals for a respectable move, but are we starting to witness something deeper?  Might there be more to this rally than meets the eye?  Is gold’s role being re-evaluated in a meaningful way as a strategic versus tactical asset?

In recent months, market has witnessed important shifts in perspective with regard to gold from some of world’s most respected wealth managers, as well as the Bank of International Settlements (BIS).  In the spring legendary investor and billionaire Stanley Druckenmiller became increasingly bullish on the metal after sharing concerns about the Fed’s loose monetary policy and prospects of inflation.  At that time, Druckenmiller also made gold his largest currency allocation.

Veteran hedge fund manager, Ray Dalio founder of Bridgewater Associates, who’s been quite vocal in recent months, warned the Fed could get locked into a debt-purchasing spiral as it buys bonds abandoned by investors now favoring rising equity and gold prices. Dalio also warned that the US dollar as the world’s reserve currency was under threat, weakened by the Fed’s unprecedented fiscal stimulus, which has gone into overdrive since the coronavirus pandemic in March. Dalio sees gold as one of the primary beneficiaries in this scenario.

Even long-standing gold bear, Warren Buffet the “Oracle of Omaha”, appears to be whistling a different tune of late.  In mid-August, Berkshire Hathaway sold substantial positions in the banking sector and announced a US$500 million dollar stake in Barrick Gold Mining Company. This is the first notable investment of Buffet’s company into a gold related vehicle, as he has famously held a negative view of the metal for not providing investors with a yield.  Today’s near zero interest rate environment certainly seems to have put a hole in the boat of this argument, at least for the time being.

And finally, last April, with surprisingly little fanfare from the media, something very important took place at the Bank of International Settlements (BIS).  Under the new Basel III rules, gold was moved from Tier 3 to Tier 1, as a zero-risk monetary asset.  Thus, the BIS will now recognize central bank holdings of physical gold as reserve assets equal to cash or a treasury bond.  This change has of course provided bullion rich banks with an upgrade to their risk profile while potentially incenting others to add to their holdings, and add they have.

For those unfamiliar with the BIS, their website mission is “to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in these areas and to act as a bank for central banks”.  The BIS is also the trading agency of the International Monetary Fund (IMF) and central banks for gold. The BIS transacts gold on behalf of its customers, which are central banks.  Some 189 banks follow the rules established by the BIS.

The purpose of the Basel III is to reduce the ability of banks to damage the economy by taking excess risk. The current version of these rules, known as Basel III, is a key element of the international regulatory reform agenda put in motion following the global financial crises of 2008. Aside from the history lesson on the BIS, these new regulations do not appear to be tactical in their nature, however quite the opposite.

A political storm is brewing around the 2020 US presidential election with neither side likely to accept defeat come November.  It seems the foundation is being laid for a potential constitutional crisis. Follow on scenarios which were perhaps once unthinkable, could potentially unfold and further cause confidence in the US establishment and critically the US Dollar to weaken. Regardless of the election result, it appears a day of reckoning for the greenback could be just around the corner. This situation, whilst regrettable, none the less bodes very well for gold.

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