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Did the Gold Standard die as soon as Richard Nixon pronounced it dead? Hardly. In fact gold standard underwent a kind of metamorphosis. Centralised gold standard became de-centralised gold standard. People took gold s..

03 Jul 2013

By Rakesh Neelakandan
Imagine that you are a nation and you have a currency. Given the poor state of the economy, nobody would want your currency. It is on a free-falling mode. Suddenly, deep inside the secret coffers of your nation is discovered a tranche of gold! Huge reserves of 99.9% pure gold bars that would dwarf US gold reserves to shame!

You can do two things: sell a portion of that gold outside and restart the economic activity and issue some decent currency in a re-incarnation. Since there is a trust reposed on you that you would be able to pay your bills, others will have no problem in lending to you. As the times pass, you simply become much more resilient and reconciled as an economy and as a nation. You have paid your bills, you have cleared your debts and wow, you are even running a great trade surplus, to the point that you are able to lend to others.

Soon your status moves from BBB to AAA and other high-class alphabets or alpha numerals. Now, the gold is as good as forgotten and it stays in the coffers of oblivion until the advent of the next big crisis.

What you may have seen is an oversimplified hypothetical example. But nonetheless, it reveals the essentials. It is not paper money that add resilience to the economy. It is some real hard asset like gold. Now, if we take into account all the paper money in circulation and weigh it against gold, you would deem that it is worthwhile to burn the money and own the gold. There is not enough gold in the planet to be supplied for all that money you have printed. As simple as that!

Now that you know about the real value of gold and assets like gold, you would also admit that it makes sense to own a piece of bullion. Now, if you are a nation, it would be far easier to keep the gold with your populace than at a central facility. Besides, ready liquidation capacity of gold would help the people there stand leveraged. This adds to the economic resilience of the people.

Gold Standard metamorphosis

Did the Gold Standard die as soon as Richard Nixon pronounced it dead? Hardly. In fact gold standard underwent a kind of metamorphosis. Centralised gold standard became de-centralised gold standard. People took gold standard to their home in a bid to preserve their wealth.

To put it another way: while fiat money helps you pay your bills, gold in physical form helps you preserve your wealth.

Whichever way you look at it, gold that has been mined since ancient times has been finite. Whatever you do, there is a limit to which you would be able to add to the above-ground reserves. This means, when speculation is rife in the market, or when there is inflation or hyperinflation in the markets, gold tends to gain value. In a way this reflects gold’s weakness and in yet another way, depending on the situation, it reflects gold’s strength.

When the situation is robust for equities to climb to which one can add value by multiple methods, gold serves as a hedge against excessive inflation. Here gold’s role is limited to that of a subsidiary power. It behaves more like the Vice President of the United States of America in constitutional and non-personalised terms.

But when there is excessive turmoil and declines in equities due to deteriorating business conditions, due to the weakening of a currency, gold behaves like a demigod, perhaps by the similar analogy mentioned above, like the President of the United States of America.

Gold invariably shoots up in value in difficult economic circumstances. Given that the reserves are of finite nature, gold is having excessive leverage in scenarios like these; which is exactly why nations that produce gold stand a better chance to weather the economic crises.

Gold mining countries

We already know that China treats gold almost like a strategic asset. Or at least, there is a thought in the similar vein in this regard amongst the policy circles in China. The nation is the biggest producer of gold.

Russia is not off the mark, as this article explains. Despite the current decline in prices, a country like US may still be able to produce gold in a profitable manner. Australia is also a big miner of gold.

The point is the future lies with gold!

The current scenario in precious metals almost resembles the 1970s sell off in the complex. Nine months saw gold declining by 50% in 1975. However, the decline was followed by a blitzkrieg recovery and the decade altogether saw gold futures going up from $35/oz to $850/oz.

The period from 1970 to 1975 saw the futures going up from $35 to $200 an ounce. From there it declined all the way to $100, giving up some $100.

But, those investors who steadfastly held to gold found the markets rallying from $100 to $850 over the next six years.

Stay put this time too and you may still benefit; if not as a futures trader, at least as a physical buyer. (rakesh@commodityonline.com)

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