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Bullion: throwing out the baby with the bathwater

Blog by Toby Birch

23rd September 2011

Unless one has been climbing Mount Everest or relaxing in a Retreat, investors will doubtless be aware of the wrenching sell-off in financial markets this week. This is having a contagion effect on the likes of precious metals which until a few days ago had been touted as a safe-haven asset. Anyone who had held them in 2008 would disagree but financial memories are short. The reason for the pulverization of precious metals is three-fold:

1. Investors are fleeing to the US dollar, erroneously called a flight to quality. Now that the Swiss have tied the Franc to the sinking ship of the Euro, there is little choice for institutional funds.
2. Historically there has been an inverse correlation between the price of commodities and the US dollar so when the latter is strong, the former are weak.
3. Because precious metals are liquid, financial institutions have a tendency to sell the good to offset the illiquidity of the bad; a case of throwing the baby out with the bathwater.

Bullion investors who understood the buying rationale in the first place will appreciate why they should maintain their holdings; looking to accumulate while others panic. Should a similar scenario as 2008 emerge then holders of gold can be comforted by the fact that it was one of the few assets to end the year positively, albeit with a 33% correction from peak to trough in the interim. In any case it is not subject to the credit risks of the vulnerable banking system, assuming one holds physical bars.

Looking at the sequence of naturally occurring Fibonacci numbers, gold may well fall below $1,600, albeit temporarily. To put this into perspective that was where prices stood two months ago. As a Sterling investor the pain will be eased because the metals are of course priced in dollars and will offset some of the losses when translated back into Pounds. From a personal point of view I have today used the sell-off to accumulate silver as I have been overweight gold and will seek to redress the balance. Needless to say, silver is much more volatile but potentially rewarding. Think F16 versus jumbo jet for the relative movement of silver to gold.

It is all-too-easy to be sucked into the vortex of short-term thinking and instantaneous media coverage. Standing back from the crowd is a lonely business, especially if one is wrong for a period of months. The key factor to comprehend is that we are undergoing a major transition in finance (as predicted in my book, The Final Crash, published in 2007). Eventually we will look back at the last 40 years as a blip when we experimented with so-called fiat currencies that had no backing with precious metals. I believe that the time is approaching when we will return to sound money. Not in the form where the money supply is fully backed 1:1 by bullion (it never used to be that way, even during the era of the Victorian Gold Standard) but perhaps on a fractional basis. The upside potential for precious metals is enormous but this is missing the point. The return to sound money will eventually crush the curse that is monetary inflation and help us into rehab where the addiction to ‘growth’ can be kicked in favour of sustainability.

It’s been quite some time since wise men came bearing gifts of gold but the markets are doing just that. So if you have no bullion under the bed or in the bank vault, it may be time to go bargain hunting while others dispense with the proverbial baby.

Toby Birch is MD of Oppenheim & Co Limited (investment management) & Guernsey Gold Limited (bullion dealing)

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