Peter's Perspective
4th February 2015 by Tama Churchouse

Gold Schmold

As Peter remains on assignment in the Alps, this edition of Peter’s Perspective is brought to you by Tama Churchouse

In our February edition of The Churchouse Letter (“A Lesson From the Mountains & Playing Profitable Defense.”) we provided an expansive view on where we think Europe is heading, and investment ideas to profit accordingly.

We received a lot of comments from our readers (which we hugely appreciate)… but in this edition of Peter’s Perspective I prefer to focus on readers who disagreed with us.

One reader in particular wrote:

“[I] don’t agree on gold. It went back to the times during GFC that the world lost confidence on paper money and USD. If we think USD is strengthening now, then gold being largely inversely proportional may suffer.

[I] also don’t agree on physical gold. Paying more storage cost, especially for small investors. Storage is significant, and if it does not pay dividend, then it is just a depreciating asset in a world of USD strengthening. Anyway, ETF will do the job.”

All valid concerns so I’ll address them one at a time…

1) “Storage [cost] is significant”

This might surprise you, but there are some pretty low cost storage solutions available for individual investors.

Let me explain with a local example from Hong Kong.

The table below shows the annual cost of a simple safety deposit box provided by Standard Chartered Bank.

I have added U.S. dollar pricing for convenience.

Table of Standard Chartered Hong Kong's prices for Safety Deposit Boxes.

The smallest available, a 2” by 5” by 22” box provides approximately 220 cubic inches of storage.

In practice there would be a fair bit of slippage so let’s round that down to 150 cubic inches. This is roughly 2,450 cubic centimetres.

Each cubic centimetre of gold weighs 19.3 grams.

So, in theory you could store up to 47 kilos of gold in the cheapest safety deposit box…. nearly US$2 million worth at current prices… probably a little unrealistic for our purposes so forget that!

Assume you only store 1 kilo of gold.

That’s worth around US$41,000 at today’s prices.

And it costs you HK$350 (or US$45) annually to store it.

In other words, you’re paying 0.11% per annum on the price of your gold.

That’s between a quarter and a third of the annual expense that major gold ETFs charge you.

What about bid offer spread costs on physical gold?

Well, Hang Seng bank which has a physical gold desk in it’s retail branch, offers bid offer spreads of as low as 0.33%.

2) “it does not pay dividend”

Absolutely right. Gold does not pay a dividend nor accumulate interest of any kind. (I hope nobody’s buying physical gold expecting income!)

But we’re buying it as a long term (albeit volatile) store of wealth in a world that continues to escalate monetary easing at a completely unprecedented rate.

Now, if my bank was paying me three or four percent annually on my U.S. dollar deposits, then clearly there’s a significant opportunity cost of holding gold.

But that’s wishful thinking right now.

At HSBC, the best time deposit I can get (for US$500,000 or above) is all of 0.20% annually… and that’s for a time deposit where my money is locked up.

If I want to keep my dollars in a simple, liquid savings account I only get all of 0.001% per annum… that’s ten bucks on a one million dollar deposit.

So if I am looking at U.S. dollar cash versus gold in terms of income, there’s no difference.

3) “it is just a depreciating asset in a world of USD strengthening”

Since June of 2014, the dollar has strengthened by nearly 20% as measured by the Dollar Index (or DXY).

The DXY is a weighted index of six component currencies against the U.S. dollar. It includes the Euro, the Yen, the Pound sterling, the Canadian dollar, the Swedish krona and the Swiss franc.

The Dollar Index (DXY) from January 2014 - Early February 2015.

You need to look long and hard to find any non-U.S. dollar denominated financial assets that have given that kind of return in the past six months or so.

But it’s worth pointing out that whilst the current price of gold is roughly the same as it was in U.S. dollar terms in June of 2014, it is not necessarily a depreciating asset…

A quick example? Well, compared to 7 months ago, an ounce of gold now buys you:

– 110% more crude oil
– 23% more copper
– 26% more corn
– 37% more wheat
– 13% more coffee
– 22% more euros
– 16% more yen
– 21% more Aussie dollars

The price of gold may not have moved much in U.S. dollar terms… but it has appreciated against many other hard and financial assets regardless.

4) “If we think USD is strengthening now, then gold being largely inversely proportional may suffer.”

Good point.

Historically we’ve seen a fairly strong inverse correlation between the U.S. dollar (as measured by DXY) and the price of gold.

The chart below shows the DXY index and price of gold going back as far as 1969. You can see that as the dollar index falls (dollar weakens), gold typically performs well… And vice versa.

The US Dollar Index (DXY) compared to the Price of Gold in US$ per Ounce, from 1969 to early February 2015.

So, if we expect the dollar to continue to rally heavily over the coming years then we should expect the price of gold to fall right?

Here is where I become hesitant.

During the last two major rallies in the dollar (and gold bear markets), i.e. 1980 to 1985 and 1995 to 2001 the U.S. offered something it hasn’t for a while now… positive real interest rates (a positive real interest rate is when nominal interest rate minus inflation is positive).

The US Dollar Index (DXY) and the Price of Gold in US$ per Ounce compared to real interest rates, from 1969 to early February 2015.

The ability to earn a positive return on your cash after inflation represents a strong disincentive to hold gold.

However, right now real interest rates in the U.S. remain negative or flat (depending on how you measure them).

In my view, to see downside pressure on gold, we need not only U.S. dollar strength but also a normalization of real interest rates.

And I think the U.S. is miles away from that…

Note: my definition of normalized real interest rates requires positive nominal rates and positive inflation… For example, a 4.5% interest rate and 2.5% inflation equals a 2% real interest rate. But a 0% interest rate and -2.5% of inflation (i.e. deflation) is also a 2.5% real interest rate. I don’t view the latter as a normalized real interest rate.

In Peter’s 2015 Investment Outlook he argued that the Fed will likely not raise rates this year. And even if they do, they’ll only do so once.

This outlook was only written in December, but I’ve seen no data to contradict that assessment.

In fact I’ve seen the opposite.

The December consumer price index (CPI) inflation reading was 0.80% year on year. The Fed’s preferred personal consumption index (PCE) reading was only 1.3%.

I don’t see how you can raise rates in this kind of environment.

And as long as real rates remain so low it’s hard to see what will force owners of gold to move back into paper currencies.

5) “[The] ETF will do the job”

I agree the ETF will do “a” job but not necessarily “the” job.

The ETF in your brokerage account is convenient, tradeable with the click of a button, and liquid.

But your ability to transact and transfer shares of the gold ETF you own depends on the solvency of your brokerage.

It also depends on your ETF provider doing exactly what it says it will.

Remember, your ETF is not gold… it’s a claim on gold.

You need guaranteed liquidity should you elect to liquidate your holdings.

And you need to assume zero regulatory friction of any kind.

Only you can determine if the risks I mention above are worth considering…

The key with physical gold is this: it’s nobody else’s liability.

Now, do I expect another Executive Order 6102* issued any time soon?

*Executive Order 6102 was President Franklin D. Roosevelt’s 1933 order “forbidding the Hoarding of gold coin, gold bullion, and gold certificates within the continental United States”.


Do I expect the world’s fiat currency system to collapse or reset any time soon?


Neither Peter nor myself are gold bugs.

We don’t hold any religious-style fervour for the stuff.

We simply recommend physical gold as part of a diverse portfolio for any number of reasons.

A primary reason being our deep misgivings about where this ongoing global money printing experiment will ultimately lead us.

And as I write this, my Bloomberg screen is flashing with news that the Australian central bank has just unexpectedly cut its benchmark rate to a record low… and the Aussie dollar has sunk to its lowest level in nearly six years…

…the race to the bottom carries on regardless…

Good investing,


Peter Churchouse Peter Churchouse is a widely respected analyst and commentator on financial markets with well over 3 decades residing in Asia. He spent over 15 years as Asia Strategist and Head of Research for Morgan Stanley as well as running a hedge fund. He shares his knowledge, insight and investment recommendations through his subscription publication The Churchouse Letter, along with his free newsletter Peter’s Perspective.
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