Gold hit a six-month low this week and is down about 7 per cent since its recent high, in April. Why the retreat?
One obvious answer is that interest rates are rising, or are set to rise, pretty much everywhere. When that happens, gold, which pays no dividend and costs money to store in a vault, loses some of its lustre (on Friday, it was trading at $1,270 an ounce; its 52-week high was US$1,365).
A less obvious answer may be the competition from cryptocurrencies such as bitcoin and ethereum. Gold dug out of the ground and cryptocurrencies created out of thin air seem to have absolutely nothing in common. The first has physical heft, practical uses, has backed some of the world’s most prominent currencies (the gold standard) and has been a traditional store of value for thousands of years; the second is digital, lives in a computer and has been around for only a decade. According to coinmarketcap.com, the collective value of the 1,600 or so cryptocurrencies it lists is US$268-billion (which is about one third of their peak value late last year). That’s a lot less than the global stash of gold – worth trillions of dollars – but not bad for fledgling, made-up “currencies” that many argue aren’t even currencies. Fortunes are being funnelled into cryptocurrencies and they are especially popular with young investors.
When was the last time you heard of anyone under 30 buying gold? To the non-geriatric crowd, gold is uncool, the “old man’s crypto” (I was on a rather expensive scuba holiday in the Maldives recently. The dive yacht was filled with Scandinavians in their 20s who had paid for the trip with their cryptocurrency gains – “money for nothing,” one of them told me).
That lack of interest from the younger crowd is compounded by recent interest-rate hikes – one of gold’s traditional party killers.
The U.S. Federal Reserve raised interest rates last week for the seventh time since 2015. The Fed’s quantitative easing (QE) program is long gone and it is now shrinking its balance sheet – quantitative tightening. Two-year U.S. bonds will pay you 2.5 per cent. Gold pays you nothing. The European Central Bank last week announced that its QE program will end in December and signalled that the first interest-rate hikes will come next summer. In Europe, negative or zero bond yields will vanish, barring another financial crisis.
The threat of inflation is also detracting somewhat from gold’s allure. The metal has always been an inflation hedge.
Investors are attracted to cryptocurrencies for some of the same reasons they are attracted to gold. Both are decentralized. There is no central authority for either. They are no one’s liability and no one is working to devalue them.
But cryptocurrencies are more attractive than gold to many investors because the former require no physical deliveries and regulation is light to non-existent. Gold is tightly regulated, from the mine site to the exchange, where, for example, margins on the trading of gold futures are high. Investing in gold is often subject to valued-added taxes and goods and services taxes. The other advantage of cryptocurrencies is that their investors, especially the ones who got in early, have an interest in supporting the currencies’ values. The day traders who play the crypto game always seem to have ample liquidity.
It’s hard to prove that competition from cryptocurrencies is hurting gold’s value. But if you believe that those currencies are in essence crypto gold, which many investors apparently do, then gold must be suffering from the proliferation of cryptocurrencies through ICOs – initial coin offerings.
The question: Which one will win over the long term – gold or the cryptocurrencies?
Gold would be my bet because it’s hard to make the case that cryptocurrencies are real currencies. A real currency has institutional support. It is, in essence, a political construct; money is not money unless you can pay taxes with it and you cannot pay your taxes with bitcoins or any of its rivals. Fiat currencies would not be worth the paper they’re printed on without any government’s insistence that they be used to fulfill tax obligations.
Cryptocurrencies have shed a lot of value in recent months. There are wildly divergent views as to whether they will go to zero or soar into the digital heavens. Gold is less prone to speculation and its owners know what it is – a precious commodity that can be touched and has withstood the test of time.
Cryptocurrencies are bubble investments unless their owners believe that governments will bestow them with legal-tender status. The chances of that happening any time soon seen remote. Over the long term, gold seems the safer bet. In the short- to medium-term, it’s anyone’s guess.
Eric Reguly