How many of us would like to walk into a shopping mall holding several grams of gold in the pocket to buy a packet of soap or other daily necessities? This is quite possible if paper currency loses its significance or value.
But why would that happen and what does it have to do with gold prices?
Think of a scenario. A scenario in which the world collapses and there are massive job losses. Economic activities tumble, companies shut their offices and factories, governments decline to honour debt and banks refuse to return our deposits. We all wish even in our scariest dream that this does not happen. This is really harsh but that is how the situation was speculated to unfold over the last few years. Europe was on the verge of collapse, US was faced with the fiscal cliff and Asian countries were running the huge risk of a slowdown. Talks of gold confiscation and fear of keeping money in banks or for that matter investing in government bonds was high. The global economic pundits are still not ruling out such probabilities and there is a belief that things could go wrong seriously and you probably might have to carry a gram of gold to buy a packet of milk. Whether it will eventually happen or not is another topic and the debate still going on.
Here prudence says that rather than waiting for the lion to come and kill us, it is better to run for cover. And this is where the investing in gold and, in turn, the spurt in its prices came into picture because everybody was running for a cover from a global economic collapse.
Owning a gun or not having a riot?
The point that I want to highlight is that we never want the global economy to collapse because that will hit all of us much harder than the gains that will be driven from our holdings of gold. It is like buying a gun fearing a riot in the street. But which is a better option, not owning a gun or not having a riot? Hopefully, if people are buying less number of guns we should be optimistic that the probability of riots in the street will be less. This is why if gold prices are falling there is a reason to believe that the world is not collapsing, which is better news rather than falling gold prices.
Still not convinced?
Consider this. Whether we invest in stocks directly or work for a company or even run a company we all have exposure to equities. The basic nature of humans as striving for means of living is the reason of our evolutions as productive societies. So be it a farmer, a worker, a teacher, an industrialist, a salaried person and a service provider we all produce a unit of product or service, which earns us a livelihood or a means of living. So far you will agree that our stakes are much higher if our livelihood is threatened than if the gold we hold loses some value. The losses that could be caused due to fall in economic activity and erosion in equity in the event of catastrophe would be far more devastating.
The foundation of the global economic collapse and the ongoing issues in developed countries is too much money supplied at too low interest rates, for a too longer period. As the fiat currency flourished due to excessive money printing by the worlds’ central banks, the world faced bouts of asset price inflation, leading to increase in cost of living. As a result of excessive spending, most countries piled up debts, which many believed would be difficult to honour when they become due. What happened in PIIGS countries only added more fuel to the fire. They are smaller, but what if the whole of Europe, US and Japan--which are having debt to GDP ratio in the region of about 70-200 per cent—-sneeze together.
The 70-30 equation
Let’s assume that one has 30 per cent exposure in gold and remaining 70 per cent in equities. Here I am assuming that even those who directly do not invest in equity markets have exposure to equity at around 70 per cent because of their profession, service, job etc. It is possible in a catastrophic situation that 30 per cent (gold) become 70 per cent of portfolio and equity (70 per cent) becoming 30 per cent. So in a bad situation the gold can save you and me. But in an optimistic scenario we have much more to gain because of our exposure to the equities. Should we then not be more interested in equities going up instead of gold prices?