Gold, A Solid Bet In Economically Uncertain Times

06/12/2016 04:53 SAST | Updated 06/12/2016 09:44 SAST

The performance of gold over the last decade has shown a constant and steady increase. If you had bought a one-ounce Gold coin ten years ago you would have paid R4,244. Today, that very same coin would be worth R17,446, a staggering increase.*

The current economic climate

Over the last year, South Africa has been adversely affected by drought conditions and electricity constraints like overloading, lack of infrastructure development and exorbitant tariff hikes which have negatively impacted the country's economic outlook. The OECD Economic Outlook states that "tighter financial conditions and low confidence" will continue to eat away at our GDP throughout the course of 2016 and into 2017. The good news is that there are avenues for stabilising your wealth in times of high inflation and depreciating exchange rates and that road is paved with Gold.

The rise and fall in the price of gold signals the general health and wealth of the global economy. Globally speaking, a rising gold price issues a warning of difficult times, whereas when gold prices drop, it indicates that investors are pulling their money out of tangible assets and beginning to back more potentially rewarding but high-risk ventures like stock. In South Africa, the Rand-US Dollar exchange rate impacts the value of Gold since Gold is priced in USD, making Gold a good Rand hedge and offering an investment portfolio protection against the ebbs and flows of fluctuating currency and volatile asset prices. In order to better understand the link between gold and currency, we need to take a step back.

Looking back: The Gold Standard

The gold standard is a monetary system which links the value of a country's currency directly to the value of gold. England was the first country to formally employ the gold standard in 1819, followed by the United States in 1834. Most of the major countries had adopted the standard by 1870 which led to a period of widespread economic growth and free trade. Support for this system started to wane after the First World War and many countries, including Britain, abandoned the gold standard and suffered a devaluation of currency. South Africa divorced itself from the gold standard in 1932 when farmers were adversely affected by the loss of exports after the onset of the Great Depression. Interestingly enough, South Africa experienced a period of economic expansion, buoyed by the revenue resulting from the sale of gold on the international market.

The gold standard, in most cases, was replaced by the use of fiat money, which is a currency issued by government declared as legal tender but is not backed by a physical commodity, as in the case of the gold standard. Since the value of a currency is no longer linked to a fixed price of Gold, currency can experience an increase and a decrease in value in relation to commodities.

The performance of gold in a downturn

One would think that gold would suffer during an economic downturn, but the results show otherwise. In the Great Recession of 2008, gold ended the year with a 5.5% gain. The team at Casey Research believe that precious metals are a "critical asset to have in your possession" when the governmental response to an economic downturn is usually to print more money. Historically, gold outperforms other investment options during times of uncertainty, demonstrating a good combination of risk and return. Risk and return are, of course, two sides of the same coin but generally speaking, as the value of the rand loses ground against the USD, the value of your gold investment will remain buoyed by the strength of the US dollar which has consistently proven to be a more stable currency than the rand.

Looking back, the value of gold increased dramatically after the onset of 2008 continuing to rise well into 2012. In that case, investors internationally were looking for ways to protect their total investment value and applied their capital to acquiring the precious metal, of which the net effect was to further increase its value due to high demand and investors were smiling.

For the South African investor, it is important to bear in mind that the value of gold is linked to the value of the US dollar, so when the South African Rand weakens against the USD, the value of gold in South Africa appreciates dramatically. The effect for a South African gold investor is compounded, making gold a great hedge bet in an unstable economy.

Gold as a solid bet

Gold, by its very nature, is valuable and has shown - time and time again - the ability to retain its value in the face of adversity. Gold has intrinsic worth, unlike the money in your savings account which could be wiped away by hyperinflation, as was the case with our neighbouring Zimbabwe. Gold is seen as a better, more tangible investment than money in the stock market that could go either way depending on how well a company performs, which in itself is dependent on so many factors. Performance on the stock market is generally poorer in times of widespread economic lows when consumer's disposable income, like his confidence, is at a low.

How to invest in Gold

Gold can be purchased in the form of gold coins or gold bullion. Krugerrands, having being created specifically for the private ownership of gold, are an easy way of purchasing the precious metal. Would-be investors should look for a reputable Gold bullion specialist who deals in Krugerrands, and who is registered with the South African Mint. Investors have the choice of purchasing a one-ounce coin or any of the smaller denominations of the coin: one-tenth, one-quarter and one-half of an ounce are the various options. The denominations are all priced at the fraction of the cost of a one-ounce Krugerrand. Gold is priced on a daily basis, depending on the daily Gold Index.

Benefits of Krugerrands versus Gold bullion

Krugerrands have the status of legal tender in South Africa, which means they are considered as currency and governed by currency laws. Krugerrands are therefore not subject to VAT making the coins easier to export out of the country. Gold bullion, on the other hand, is charged including VAT and is more difficult to export. Should your investment portfolio include offshore wealth, you should consider Krugerrands as a viable vehicle for which to grow your wealth.

*Based on today's Gold Index.