The Australian dollar's gold bonus

Exit gold the commodity. Enter gold the currency.

Those eight words cover the two-faced nature of gold: a commodity to some people, a currency to others – and, in what might be a surprise to its critics, it has been one of the better-performing investments over the past month.

Unlikely as it sounds, gold did outperform most other investment classes in May, and despite its steep fall over the past two years it has also outperformed some of Australia’s biggest ASX-listed companies in that time.

To the May performance first, because in April, gold was trashed, shedding $US114.50 an ounce to $US1,469.50/oz. The fall continued this month, when measured in US dollars, selling for around $US1,414/oz last night.

But, the gold picture is different for investors in Japan, South Africa, Australia and a few other countries where, on conversion to their home currency, it has risen during May.

In Australia, the domestic gold price has been aided significantly by an exchange-rate fall from $US1.0367 on May 1 to around US96.74 today, a decline which means the Australian-dollar gold price has risen from $A1,417/oz to $A1,461/oz, a gain of $A44, or a rise during May of about 3%.

Click to enlarge

Source: Bloomberg

Modest as that 3% looks, it is certainly better than the 4.4% fall in the ASX All Ordinaries Index over the month. And, while the gold price increase in May does not offset the fall in April, it is a reminder that gold can move in different directions (at the same time) because of its unique commodity/currency status.

The problem for most investors when they consider the appeal (or not) of gold, is that it is an asset class which generates strong views.

There are believers and non-believers and, if that sounds a bit spiritual, the comparison can be taken further because there are extremists at both ends of the spectrum.

Gold-haters cannot accept that a simple commodity, which is nothing more than metallic element No.79 on the periodic table, can have any monetary value given that it has few uses, except in some dental and technology applications, or as a body adornment.

Gold-believers point to the thousands of years during which gold has been treasured as a store of wealth (by civilisations on every continent) and as an insurance policy against bad governments that cannot manage their economies or (paper) money supply.

The believers particularly like the way governments accumulate gold in preference to having all of their reserves in the forms of another government’s currency, or other forms of promissory notes.

As with any complex question where there are conflicting views, it is best to discount the extreme opinions. Non-believers in gold will never be convinced, and some true-believers (the gold bugs) can fall victim to the conspiracy theories that pop up occasionally.

The latest favourite of the gold bugs is that the big price fall in April was either an investment bank conspiracy, or the work of the US government.

They refuse to accept that gold’s big fall was simply a case of an investment class running out of steam after 12 “up” years, an astonishing record that is probably unmatched by anything else.

“Aah”, say the detractors, “but gold has been in a downward spiral since hitting its all-time peak of $US1,875.30/oz in early September 2011, which makes its latest US dollar price of $US1,414 a 24.6% fall, enough to qualify as a crash.”

There’s no arguing with that, but the same sort of argument can be run against many of Australia’s biggest companies.

BHP Billiton, for example, peaked at $49.55 in April 2011, and was last night trading at around $34.46, a 30.1% fall, which is also enough to qualify as a crash.

The best, if not the only safe way to view gold, is as an insurance policy. And just as it is possible to be over-exposed to gold (over-insured), so too is it possible to be under-insured, a potentially expensive mistake if your house burns down.

Growing confidence that the global economy is less likely to “burn down” today than it was at any stage during the roller-coaster ride of the past five years is one reason why gold has been falling in US dollar terms.

Another reason is that the US is leading a sluggish worldwide recovery and its currency is performing accordingly: rising while other currencies fall.

The slow recovery, and grave uncertainty about the future of Europe and its common currency, is one reason to worry about the future value of paper money. Another is more countries following Japan, which has actively encouraged a dramatic devaluation of its currency in the hope of stimulating its export industries.

Japan’s trashing of its own currency has raised the potential for reciprocal action by its trading rivals, creating the perfect conditions for a currency war where the last man standing could be gold.

The risk of trade and currency wars is the latest reason for maintaining exposure to gold, and if you don’t have any it might be wise to think seriously about underpinning your portfolio with a modest holding. But have no more than between 5% and 10%, and preferably in its metallic form, which is how the central banks of most governments like their gold.

What you are acquiring with gold is a class of investment that is beyond the reach of government – and isn’t it interesting that most governments own gold and continue to be buyers, despite two years of a declining gold price?

For an Australian investor, the gold question really is all about currency values, as May’s 3% rise demonstrates, and which shines through if the current crop of gloomy currency forecasts are correct.

As a case study, consider today’s US dollar gold price of $US1,414/oz. If or when the Australian dollar slips to US90c, such an exchange rate would lift the gold price to $A1,571/oz, a rise of around $A110a/oz, or 7.5%.

At an exchange rate of US80c, a value being tipped by some commentators, the Australian gold price today would be $1,767/oz – and just to round out this exercise in crystal ball gazing, the local gold price at the average exchange rate since the Australian dollar floated of US75c would be $A1,885/oz.

This then is the currency-insurance factor of gold, which is one of the better hedges available to Australian investors as the country’s economy hits an air pocket caused by the end of the resources boom and the uncertainty of future government policy.

For tipsters who say that gold will continue falling, and there are plenty of those, the question to ask is, “in what currency?”

They might be right in US dollars, but they will probably be wrong in Australian dollars.

Just as you insure your house and car, a small holding of gold is a nifty form of exchange-rate and portfolio insurance.