Is there any benefit for Aussies to invest in gold?

November 16th, 2010

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Recently, one of our readers who bought How to buy and invest in physical gold and silver bullion wrote to us,

I live in Perth so am looking to buy bullion from the mint, just down the road, literally, however I?m concerned about how the fluctuating US dollar affects my investment. Surely during hyperinflation of the US dollar gold will obviously go up, but also the Aussie dollar will strengthen significantly at the same time. If the Aussie dollar goes up more than the gold price, I actually loose money in Aussie dollars for which i use to pay my gold (If I use us money trading account…i will loose money when i finally exchange us to aus $$ if the exchange rate is super high)…is this a realistic situation or in a case of hyperinflation, is gold likely to spiral upwards whereas the Aussie dollar marginally increase in relation to the US$…….i.e will the spiralling gold price and hyperinflation in the states cause equivalent hyperinflation worldwide and therefore maintain the “approx” AU/US $$ exchange rate.? I can see gold skyrocketing but if the Aussie dollar also sky rockets also…this is of no benefit is it>>> or is it???

our dollar is very strong at the moment and predicted to get stronger, hence, i will loose money by investing in gold or silver, but i have no trust in the US financial system. Is there a way i can hedge myself against a strengthening Aussie dollar??

I realise u don’t have a crystal ball…I’m not holding you to anything i just want your opinion.

As we can all see, currently there?s a correlation between Australian dollars (AUD) and gold price. Hence, from the point of view of Australian investors of gold, a rising gold price (in USD) does not benefit them. We see that correlation working out in 2007 and today. Today, even though gold prices had hit a record high in USD terms, it is still below the record high in AUD terms- gold hit a record high of around AU$1500 in 2009 when the AUD was very ?weak?.

To answer our reader?s question, we have two points to make:

Back to the basics?

First, let?s revisit the basics. As we wrote in How to buy and invest in physical gold and silver bullion, when we invest in gold, we are not so much into ?making? money. We are doing so to hedge and protect our existing wealth. In other words, gold is not so much of an investment. Instead, it is more of an insurance policy. Therefore, we wouldn?t be so concerned if our ?investment? in gold is not turning out well in terms of AUD. However, what we are more concerned is the possibility of an AUD currency crisis. We have written about that in Will there be an AUD currency crisis?. We are not saying it will happen. Instead, we are suggesting that there?s a possibility that it may happen and by ?investing? in gold, we are hedging ourselves against that.

USD the reserve currency

Regarding the mess in the US financial system, it would be quite an entertaining spectacle if the US is just an inconsequential banana republic like Zimbabwe (which incidentally fell into hyperinflation- a object lesson for the US to learn). In that case, the case for ?investing? in gold will be much weaker.

Unfortunately, the US is not an inconsequential banana republic. It is a superpower whose currency is the world reserve currency. As we wrote in How to buy and invest in physical gold and silver bullion,

The United States, with ?helicopter? Ben Bernanke at the helm of the Federal Reserve, is committed to money printing to solve America?s economic woes. To the extent that the US dollar is the world reserve currency, it will affect the rest of the world.

Because it is the world?s reserve currency, China ?saved? most of the fruits of its hard work in the form of that reserve currency (a cool US$2 trillion worth). Same thing for Japan. Ditto for many other countries.

By printing money, the US is devaluing the world?s reserve currency. But the world cannot afford to have its reserve currency devalued towards the value of confetti. As we wrote in Why did the foreigners bail out cash-starved financial institutions?,

China?s trillions of US dollars reserve is a form of savings that will be used to acquire their future needs for resources to power their economy in the long term. Therefore, any threat to the long-term value of their savings will be a long-term threat to their economy.

So, what is the solution to the devaluation of the reserve currency? As we wrote in What if the US fall into hyperinflation?,

Now, in this age of freely fluctuating currencies, the currency?s value is a relative concept. For example, a falling US dollar implies a rising Australian dollar. Therefore, one way to ?maintain? the value of the US dollar relative to the Australian dollar is to devalue the Australian dollar. Perhaps this is the route that central bankers will concertedly take to instil ?confidence? in the US dollar in order to create the illusion that the US dollar is still a reliable store of value? Well, they can try, but growing global inflation and skyrocketing gold price relative to all currencies will be tell-tale signs of such a dirty trick.

That?s why there?s a threat of a currency war between the US and China right now. The US is accusing the Chinese of manipulating their currency while the Chinese are pissed off with the US for exporting their inflation to China. As the US prints and devalue its reserve currency, China will be hard pressed to devalue theirs too (in the form of a currency peg). If China let their yuan soar in value, their exports will collapse, which will severely affect their economy and social stability. Japan is in the same situation too. A strong yen (relative to the USD) is very bad for their economy too. That’s why Japan recently cut their already super-low interest rates and there’s talk of more money printing on the Japanese’s part.

Now, look at Australia. Let?s imagine that the AUD reaches US$1.20 and is threatening to march forward to $1.40 and beyond. If the AUD gets too strong, it will hurt the Australian economy. In such a situation, Australia will be hard pressed to devalue its currency too (e.g. by cutting interest rates, direct intervention). Or maybe impose capital controls.

In other words, the world is in a situation where there?s a competitive devaluation of currencies. In the recent G-20 summit, countries are pledging not to engage in that. Well, if you doubt their words, then you will sleep better to have your own reserve currency in the form of gold.

In any case, it?s going to be very rough ride in the forex markets. If you are forex speculator, this is heaven. If not, then it is going to suck.

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  • Pete

    Semi-related topic… I had a thought the other day:

    What if the RBA is trying to keep the AUD high to protect Australia from having it’s asset’s poached by foreign countries trying to get rid of their USDs?

    If so, a high AUD has a double effect in this regard.
    1) it makes our companies cost more to buy out
    2) it makes our companies less profitable and less rewarding to buy out

    It is just a thought anyway. No evidence…

  • Pete

    Sorry, on-topic:

    There is no way to tell exactly where gold will go on AUD terms.

    However, as I have mentioned in a previous comment, if the AUD depreciates, or gold appreciates, it is likely that gold will appreciate in AUD.

    Worst scenario for gold price in AUD is a depreciation in gold price and an appreciation in AUD.

    But you have to ask yourself in that last scenario – isn’t this a good thing? An appreciating AUD against a stabilising world economy? So what, you have some gold that is worth less. Your ‘insurance’ didn’t pay out. It doesn’t matter, you are living in a time of prosperity. Get over it!

    But if your insurance (gold, duh) does pay out, then you get a little win whilst the world economies struggle and you have to fight for the things you used to take for granted.

    Just trying to put things in perspective.

  • Hmmmm…..

    That may backfire though. Speculators may see that anything ‘invested’ in Australia may increase in ‘value’ solely by of the effect of rising AUD.

    With Bernanke printing money willy nilly, there’s no shortage of USD to ‘invest’ in Australia.