Alessio Rastani: Is gold a safe investment in a financial crisis?

Remember the trader who told the BBC that “Goldman Sachs rules the world”? This is his column

Our columnist Alessio Rastani is the self-proclaimed trader who shocked the world by declaring live on BBC News that he goes to bed “every night dreaming of the next recession” and that “Goldman Sachs, not the governments, rule the world”. He’s a controversial figure, not least because he’s a self-taught non-institutional trader with no FSA license. But he certainly isn’t shy about sharing his views. Do you agree with his words? (His words are his own, and in no way endorsed by LondonlovesBusiness.com)

Whenever the markets go into some kind of turmoil, I always start to hear the same old nonsense over and over again. One piece of misinformation after another.

One particular favourite of mine is an “old wives tale” about gold.

Gold is seen by many investors as a safe haven, and perhaps for good reason. 

It is arguably a safe hedge against a devaluing currency like the US Dollar. Further printing by the central banks will no doubt put further downward pressure on the currency and conversely boost gold.

Many investors also see gold as a protection against the threat of hyperinflation in an apocalyptic future.

All of the above are good reasons for holding gold as an investment.

However, most people don’t seem to understand what is meant by the “safe haven” status of gold.

The Flight To Safety

Last September the world seemed to be on the brink of a global recession and the markets were in deep turmoil. 

The question on everyone’s lips is that what is “safe” to invest in and answer to that provided by many financial blogs, social media sites as well as “experts” was – gold. 

In actual fact the “gold bubble” which started in 2009 fizzled out about the same time when the economy faced another challenge. In September 2011 gold dropped from its highs at $1900 an ounce to just below $1600 and is currently still valued at that same level. 

The 2008 recession saw gold losing 25% of its value when it dropped from $1000 to $750.

So what’s going on? Why is gold dropping when it “should” be rising given the economic uncertainties?

The truth is that in a financial crisis, when investors are getting jittery about the markets, all asset classes get sold – including gold (and silver).

This is known as the flight to safety. 

When hedge funds are taking off risk (i.e. moving money away from stocks) they move it into safety.

Again, most people are under the impression that “safety” in this context means gold and silver.

No.

The flight to safety means a flight to liquid safety.

Liquid Safety

Liquidity means how easily and quickly an asset can be sold without incurring losses and affecting the price of the underlying asset.

Hedge funds seek liquidity – and precious metals like gold and silver are not liquid.

Gold and silver are liquid for us, the retail investors. We could move money into and out of gold without much difficulty.

However, for a billion dollar hedge fund gold and silver are not liquid. A billion dollar hedge fund cannot just move money in and out of metals without incurring losses.

So in times of economic uncertainty or a financial crisis, hedge funds will seek safe liquidity – and by that we mean US Treasury bonds and the US Dollar.

The US Bonds are still the world’s most liquid safe havens.

Most people find it confusing that the US Dollar is referred to as “safe” in this context.  Surely the dollar is a devaluing currency and on its way down?

Yes, again it is true that the dollar is devalued by inflation and printing.  However, in times of economic uncertainty such as we have witnessed in Europe recently, investors will ditch the Euro and move their money into the US dollar.

Both currencies stink of course, but it just so happens that the dollar has a less pungent smell!

Investors also will also seek the relative safety of the US bonds to escape the crisis in the eurozone.

In summary, it is important to appreciate the context in which gold (and silver) are seen as “safe”.  We have seen that in recessionary periods gold prices have dropped – a sign also that perhaps gold is being sold to raise cash. 

A lot of myths and false assumptions are held about gold and markets in general. 

Understanding the markets can help investors make better decisions instead of relying on a false “common sense”.

For further information about trading the markets visit my website www.LeadingTrader.com.

Alessio Rastani gained fame and caused controversy last year by stating live on BBC news that he “dreams of another recession” and that “Goldman Sachs, not governments, rule the world”. The YouTube clip has since been watched over two million times, and Alessio has subsequently been interviewed by figures such as Sir David Frost. His website is LeadingTrader.com.