So let's have a field day with the shrink and get on the couch.
If you eschew financial engineering and/or the use of diversification to protect wealth then please stop reading....
here.
This represents a trade/exposure management transaction which I expect to be implementing in the period ahead. These are my considerations.
Gold is a store of wealth whether held in central bank vaults, ETFs, as direct investments and even significantly in the form of jewelry which is not notionally classed in that fashion. Only a fraction is used for industrial purposes. Extracts from the World Gold Council in relation to jewelry use in the biggest buying nations of China and India are provided below.
It is a pseudo currency because it serves as a store of wealth. Two charts below also display how AUDEUR performs with GOLD(EUR) and similarly for the US equivalent:
The fact that these lines move somewhat similarly outlines the characteristics of gold as a type of currency. There are many arguments about why gold serves as a monetary asset. I just observe it to be the case in practice. Central banks are accumulating. They do not do so with other precious metals, diamonds.... to them, it is a reserve asset, mixed in with USD t-bonds etc.
I have a fair chunk of assets, proportionately, held offshore and the Australian equity market is also heavily exposed to the currency. I don't mind having offshore exposure for a lot of reasons, not least of which is that it helps hedge my expenditure stream. When the AUD depreciates, costs go up as per Q4 2013.
Gold is presently trading close to the bottom of the all in total cost curve and demand is not shrinking. Whilst it might get worse as secondary supply can take its place, there is a limit to this unless the world stops buying gold for some reason.
The world is suffering lowflation. This is priced. There is a wing risk of inflation surprise. I already have ILB to protect against domestic inflation. Further, the BoJ print now exceeds the Fed and ECB will likely start printing in Oct. It does not seem like a stupid idea to own gold outright if your only choice was a basket of currencies. It is useful to imagine what you would do to increase your wealth in world terms when all you had to invest in are deposits in different currencies and gold. Personally, I would have some gold if in that position....wait a minute, I am in the position. I would not hold this belief if gold prices were trading well to the right of the all in cash cost curve before interest payments, QE wasn't all over the place and debt overhang so large.
However, my offshore exposure is dominated by USD and Euro. USD exposure is gained via US investments (bonds and equities) and also via emerging markets as some countries pay bond coupons in USD.
As the ECB prints via TLTRO, some of this will flow into offshore FDI and portfolio investment, weakening the EUR. This is what happens in QE and it is an intended effect. Check out Japan - they are the world beaters. I have less conviction on the outlook for the USD. It will likely rise.
I don't know. Taking a conviction stance with zero information is nuts, in my view. I am not a punter. So, I want to change the mix of my offshore currency exposure from USD and EUR into Gold for a portion....about 10% of offshore currency exposure, or something akin to a JPY exposure.
Other things. I don't want to change my exposures otherwise. I want to be able to own the gold, or a claim to it which is readily converted to the metal itself. PMGOLD-ASX does the trick, but I could just buy the metal. As I don't think I actually need the metal in my hands (arranging storage and security etc.) in Australia I'm happy with the rights. At 1% round trip including brokerage, that's alright and in-line with bullion. I can turn up at the door with my certificate and a form and collect my gold in the same way.
So, I want to shift some exposure from USD and EUR into Gold. I don't want to change my exposure to cash. How is this achieved?
1, Buy PMGOLD
2, Sell EUR for AUD and Sell USD for AUD in appropriate proportions.
I now have the same effective exposure to cash, and have shifted some of my exposure to USD and EUR into gold. I own the metal/rights. The gold is now a capital asset which will be on a hold-to-death basis. Whereas the cash was on income and the ATO is clipping tickets. I have FX contracts whose expected value is conservatively zero less the tom-next margin plus admin, say, 0.65% per annum. In reality there is an expected pick-up due to positive carry that would eliminate that, but let's call that a cherry on top. I have a more comfortable exposure to a currency basket which includes a measure of protection against geopol and inflation surprise and whose relevance as a store of value by investors, central banks and notional consumers of jewelry looks pretty solid. Good enough for a central bank, good enough for me. If all gold does is perform in line with cash in AUD over the longer term, then this will lead to an after tax outcome equivalent to a very nice TD (including realisation of gold profit, obviously better if not), but also comes with an option on top of that protects against certain extreme events whilst limiting country risk in the offshore exposures.
...all for a fraction of the overall portfolio value. But this stuff counts to me and it all adds up. One percent per annum over 40yrs et al. Limit blow up risk etc.
What could go wrong?
AUD elevates vs world currencies on a secular basis in manner which does not elevate gold with it;
Gold behavior changes to a consumption item and demand drops a lot as a result;
Confiscation of gold in an emergency of some sort...don't laugh..it happens;
Change of tax treatment on any aspect;
Operational risk with trading, rolls, margin management, technology outage; and
New substantive low cost mine development.
I'm ok with that.
Thanks Doc.