Physical Gold In Vault Is “True Hedge of Last Resort” – Goldman Sachs

Currie released a note arguing that gold’s strong performance of late is less to do with the current perceived risk in the geopolitical sphere and instead from the currency debasement that arises from central banks printing money.

In light of this, investors should be buying up gold. Goldman’s Currie refers to gold as the ‘geopolitical hedge of the last resort’. This is the case ‘if the geopolitical event is extreme enough that it leads to some sort of currency debasement’ and especially so ‘ if the gold price move is much sharper than the move in real rates or the dollar.’

Read on to see in exactly what form Currie believes you should be investing in gold.

It has become too easy to pin gains on geopolitics

As we have repeatedly pointed out, the gold price jumps following events such as North Korea testing missiles or Hurricane Harvey or a declaration from Trump. However these jumps are not frequently sustainable.

What is going on in the U.S. and global markets and economy which really provides long-term support for the every-strengthening gold price.

Currie writes:

“It is tempting to blame the rally in gold prices on recent events in North Korea. While these events have helped to create a bid in gold, they only explain [roughly] $15 of the more than $100 [per ounce] rally since mid-July.”

It is too easy to pin gold’s rise on geopolitical events. Instead, argues Currie, these events are only really impacting gold if they lead to ‘actual currency debasement.’

Instead, the recent rally has been down to the decline in the U.S. dollar and lower real interest rates.

Gold Price & Five-year rates, 2007 - 2016

Gold is the currency of the last resort - Click to enlarge

This dynamic is captured by a negative correlation between gold prices and real interest rates. As the central bank prints more currency, the price of the currency as measured by the real interest rate declines. The lower real interest rate, in turn, reduces the opportunity cost of holding a real asset like gold, leading the market to bid up gold prices. So at the core, gold is a hedge against debasement, which is why we have termed it the “currency of last resort.” 

Bigger things to worry about than Korea

Interestingly gold’s move this year has had far more to do with President Trump than it has to do with North Korea.

Currie argues that Kim Jong-Un might only be responsible for 15% of the yellow metals’ move. 85% of the price rise can be accounted for by the fact that  the Trump risk premium is reflected in both real interest rates and a weaker US dollar.

Gold price & USD based Gold value, Sep 2016 - 2017

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We find that gold can effectively hedge against geopolitical risk if the geopolitical event is extreme enough that it leads to some sort of currency debasement, and especially if the gold price move is much sharper than the move in real rates or the dollar. For these events, gold essentially serves as a call option and can therefore be thought of as a “geopolitical hedge of last resort.” For example, gold served as an effective hedge after the events of September 11, 2001 when the US Federal Reserve substantially increased dollar liquidity, debasing the US dollar. Gold also proved an effective hedge during the Gulf Wars as governments printed money.

Facilitation recovery

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