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Hedges

Precious Metals: Buy the Dips

By Elliott H. Gue, on Jul. 28, 2016

Investors shouldn’t dismiss gold and silver as plays on a weak US dollar. Although gold tends to fare well when the greenback loses some of its value, the precious metal is a currency in its own right and acts as a hedge against weakness in all paper currencies.

Consider that the US Dollar Index, an average of the exchange rates between the greenback and major world currencies, has increased slightly since the end of November 2015. The spot price of gold, however, has surged by 23.7 percent over the same period.

More important, gold prices tend to benefit when investors lose confidence in the major central banks and the currencies they manage.

The total supply of above-ground gold has increased by 17.5 percent over the past decade and stands at 5.89 billion ounces. Meanwhile, total US money supply (M2) has grown by almost 87 percent to $12.85 trillion.

(Click graph to enlarge.)
M2 and Gold Supply

Whereas central banks can create money on a whim, the supply of above-ground gold climbs slowly over time—one reason why the yellow metal has retained its purchasing power for centuries.

With major central banks pursuing quantitative easing and experimenting with negative interest rates, investors have started to lose confidence in currencies and central banks’ ability to promote sustainable economic growth through monetary policy alone. This skepticism has increased gold’s appeal as a hedge.

Although gold prices have pulled back somewhat of late, the amount of physical gold held by exchange-traded funds has continued to hover around 64 million ounces. Robust demand for gold among investors could propel the precious metal’s spot price to more than $2,000 an ounce at some point in 2017.

(Click graph to enlarge.)Gold Held by ETfs

We’ve outlined the basic case for owning gold, silver and shares of miners that produce these commodities in previous articles. (See, for example, Stay Golden.)

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