I was trying to explain about gold's currency neutrality - and i don't quite know how to explain it directly though. I attach my reasoning below. Would appreciate help on how to explain about gold's 'currency neutrality', and whether my conclusions about how gold investment should be viewed and conducted in non U.S. country is appropriate.
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Right, so I will talk about gold's currency risk, or neutrality. I had asked mysef your questions on gold's currency risk before I started my portfolio, and it was quite hard for me to answer. Then I think they are not directly relevant, so I asked myself two better and more relevant questions instead...
1. Is buying/selling of gold in Singapore dollar and U.S. dollar the same?
Here are some past forex data from Oanda:
XAUUSD = gold price in U.S. dollars (US$)
XAUSGD = gold price in Singapore dollars (S$)
USDSGD = exchange rate, amount of Singapore dollars needed to buy one U.S. dollar.
XAUUSD_XAUSGD_USDSGD_Date
958.35__1489.96_1.5579__2008, Mar 02 - Day High
1721.74_2150.10_1.2520__2012, Mar 02 - Day High
1st case - Singaporean buy/sell 1 ounce of gold in SGD
Mar 2009 Buy cost: 1489.96 sgd
Mar 2012 Sell price: 2150.10 sgd
Profit= 2150.10-1489.96 = 660.14 sgd = 44.3%
2nd case - Singaporean buy/sell 1 ounce of gold in USD
Mar 2008 Buy cost: 958.35 usd = 958.35*1.5579 = 1493.01 sgd
Mar 2012 Sell price: 1721.74 usd = 1721.74*1.2520 = 2155.62 sgd
Profit = 2155.62-1493.01 = 662.61 sgd = 44.4%
Conclusions:
-For both cases above, the profit is same at about S$662.61 or 44.4%, hence it is the same whether a Singaporean buy/sell gold in SGD or USD. It may be better to buy gold in SGD to avoid paying slightly extra due to exchange rate spreads charged by brokers.
-Singapore dollars has strengthened against U.S. dollars by about 19.6% from 2008's 1.5579 to 2012's 1.2520. In that period, gold in USD (XAUUSD) gained 79.7%, while gold in SGD (XAUSGD) gained 44.3% only. Yes, gold profits in Singapore dollars seems to be lesser in SGD than in USD... this is not really a problem because the SGD denominated stocks and bonds in the portfolio have gained 19.6% against USD, increasing buying power of portfolio in USD terms.
A little confusing? Yes, because we really shouldn't compare how gold performed in USD vs. gold performance in SGD. We should look at how our invested gold performed in SGD only, because we are earning and paying our bills in SGD at retirement (assuming that's the investor's plan). Gold and real estate property are a type of investment class termed as 'hard asset', which holds its value during inflation (as opposed to paper assets 'stocks', 'bonds' that can lose value during inflation). When a Singaporean buys local property, he/she only cares about the property price in SGD, so the same is for gold. Not convinced yet? Then I can only answer the second relevant question, which is...
2. Should a Singaporean investor do currency hedging against gold priced in USD?
Using forex data from Oanda again:
XAUUSD_XAUSGD_USDSGD_Date
958.05__1295.87_1.35000__2008, Jul 21 - Day Low
958.35__1489.96_1.55790__2009, Mar 02 - Day High
From 2008 Jul 21 to 2009 Mar 02,
XAUUSD Profit = 958.35/958.05 = 0%
XAUSGD Profit = 1489.96/1298.87 = 15.0%
USDSGD depreciation = -(1.5579-1.3500) =-15.4%
Conclusions:
-Compared to USD, SGD currency devalued by -15.4%. Currency devaluation can be caused by inflation. This SGD currency devaluation lowered buying power of SGD assets in portfolio. On the other hand, gold in SGD (XAUSGD) in the portfolio rose 15.0%, and contributed to portfolio profits and helped protect against devaluating effect of inflation. This will only be true if the gold is not hedged against USD.
-If gold investment was hedged against USD, gold's profit in SGD will mirror the profit of gold in USD (XAUUSD), which is 0%. Meaning, gold when currency hedged to other currency loses its ability to provide inflation protection effectively for local currency SGD. Hence, gold investments should not be currency hedged to other currencies in order to retain gold's inflation protection effect for local currency SGD.
Final conclusions:
The two answers above are enough for me to do my gold investment. First, I understand that I should buy and track my gold investment in SGD. Yes rising SGD can lower profits of gold in SGD compared to other currency, but this is not a big deal since my other SGD stock, bond and cash assets appreciate in value against the other currency also... I also noted that it only make sense to view gold performance in SGD, in order to see gold's inflation protection effect on SGD. Second, I do not need to do currency hedging on my gold investment, in order to let gold's inflation protection function work for my local SGD currency when necessary.
Gold's currency neutrality and investing
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Gold's currency neutrality and investing
Last edited by Coearth on Sun Sep 09, 2012 7:45 pm, edited 1 time in total.
Re: Gold's currency neutrality and investing
Woot..i figured out the answer about gold's currency neutrality, with some help:
The short answer is that Gold is not a 'fiat currency denominated asset'! E.g. Gold is not a USD denominated asset. Gold's value as a medium for trading of goods does not depend presence or survival of any currency system. Gold has value for exchange of goods even if all fiat currency systems fail, so gold is currency neutral and independent of fiat currency survival (it is fiat currency that can be dependend on gold instead). We do not hedge our gold investment to any currency, for similar reasons that we do not hedge our house, gems and cattles to a fiat currency.
'Paper assets' such as bonds and shares are 'fiat currency denominated assets' (eg. U.S. Treasuries is USD denominated). The currency risks in 'paper assets' is such that if the currency fails, the 'paper asset' like bonds and shares will be of zero value immediately.
The long answer is below, extracted from my post elsewhere:
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What I am showing primarily, is that I verify even the simplest assumption first before using it to make a decision. Which brings me to my second point...
The theory in my above second point is about whether I should do currency hedging when owning gold as an inflation hedge. Gold, houses, gems, and cattles, collectively known as hard assets, are historic store of value and wealth. I know i shouldn't hedge houses, gems and cattles against other currencies, so i feel funny that i should be thinking to hedge gold against USD. Throughout the thousands of years of human civilizations history, i would think people used gold by itself as a store of value, and I have not really heard about people in historic times hedging physical gold against a fiat currency (legal tender paper money). Again, it feels very stange to me that modern day people, including myself previously, should feel compelled to hedge gold to USD. So I checked my assumptions using actual forex data, and found that my hunch is right, that gold in reality should not be hedged to other paper currency, in order to preserve gold's inflation protection capability. I think it is safe to say that there is a few thousand years of history to support the theory of using gold as an inflaton hedge against paper money's devaluation. I think it is also safe for me to say if i do a hundred more sample calculations, i will still get the same conclusion that to ensure gold's effectiveness as inflation protection, gold investment should not be currency hedged to US dollar. Having established this fact, and based on your replies, I have come to a new and 3rd point...
Gold is not considered a USD asset - this view will then not contradict my first 2 points above! I am going to verify that gold is not a USD asset. The 'hard asset' class, such as gems, cattles and houses, are not commonly considered as USD asset, hence, gold, being a hard asset, should not be considered as USD asset also. What are USD assets then? More accurately, USD assets refer to USD denominated 'paper contracts' perceived by people to be worthed certain amout of paper money. Some commonly recognized USD assets are U.S. company shares and U.S. Treasury bonds, denominated in USD. Such bonds and shares, belongs to the 'paper assets' class. The fundamental difference between 'hard asset' gold and 'paper asset' shares is this: 'hard asset' gold, gems, houses, cattles will still continue to physically exist and represent value to people even if the prevailing currency suddenly disappears; on the other hand, if a currency disappears, the shares and bonds based on the currency can likely be practically declared worthless overnight.
Need a semi-hypothetical example? If not, skip this paragraph. Imagine during the occupaton of Singapore in World War II, the occupiers created the 'banana money' currency and banned all other pre-existing currencies. Imagine during the occupation, one gram of gold could have initially equaled 10 dollar banana money. Person A is holding onto one gram of gold and person B is holding on to 10 dollars of shares and bonds issued in banana money. Through time, the occupiers simply printed more banana money when they needed it. The subsequent large increase in amount of banana money in circulation causes hyperinflation and severe depreciation of banana money. Before the inflation, Person A's one gram of gold can buy 100 loaves of bread; after hyperinflation, prices of gold and bread rocketed up very sharply, so relatively speaking, one gram of gold can still exchange for 100 loaves of bread, give or take a bit. For person B, before the inflation, 10 dollars of shares and bonds in banana money can be exchanged for 100 loaves of bread; after hyperinflation and severe currency depreciation, 10 dollars of shares and bonds in banana money can now be exchanged for ony two loaves of bread... and if this is not bad enough... After the occupiers eventually lost and surrended and left Singapore, the banana currency became worthless quickly, and person B's 10 dollar shares and bonds denominated in banana money are now worthed practically nothing...
(The currency was also referred informally, and with more than a trace of contempt, as banana money, named as such because of the motifs of banana trees on 10 dollar banknotes)
Conclusion: Gold is not a USD asset. This misconception about gold being a USD asset is due to popularity of seeing gold price being reported in USD, causing non U.S. people to subconciously think that gold is similar to U.S. shares and bonds and classified as USD 'denominated' assets. Gold, being a 'hard' currency itself, has no USD currency risk because gold's intrinsic value for exchange of other goods is not 'risked' by any devaluation or destruction of U.S. dollars (or any other 'paper' currencies). In contrast, A Singaporean who owns 'paper' assets like U.S. stocks and bonds, are exposed to the currency 'risk' that USD may one day 'devalue' greatly against SGD and cause severe investment losses, or their USD investment may be unconvertable back to SGD if U.S. government one day declares that Singapore cannot transact with U.S. dollars anymore.
Finally, here is one of my favourite quote:
~Sherlock Holmes:
"When you have eliminated all which is impossible, then whatever remains, however improbable, must be the truth."
The short answer is that Gold is not a 'fiat currency denominated asset'! E.g. Gold is not a USD denominated asset. Gold's value as a medium for trading of goods does not depend presence or survival of any currency system. Gold has value for exchange of goods even if all fiat currency systems fail, so gold is currency neutral and independent of fiat currency survival (it is fiat currency that can be dependend on gold instead). We do not hedge our gold investment to any currency, for similar reasons that we do not hedge our house, gems and cattles to a fiat currency.
'Paper assets' such as bonds and shares are 'fiat currency denominated assets' (eg. U.S. Treasuries is USD denominated). The currency risks in 'paper assets' is such that if the currency fails, the 'paper asset' like bonds and shares will be of zero value immediately.
The long answer is below, extracted from my post elsewhere:
----------------------------------------------------------------------------------------------------
What I am showing primarily, is that I verify even the simplest assumption first before using it to make a decision. Which brings me to my second point...
The theory in my above second point is about whether I should do currency hedging when owning gold as an inflation hedge. Gold, houses, gems, and cattles, collectively known as hard assets, are historic store of value and wealth. I know i shouldn't hedge houses, gems and cattles against other currencies, so i feel funny that i should be thinking to hedge gold against USD. Throughout the thousands of years of human civilizations history, i would think people used gold by itself as a store of value, and I have not really heard about people in historic times hedging physical gold against a fiat currency (legal tender paper money). Again, it feels very stange to me that modern day people, including myself previously, should feel compelled to hedge gold to USD. So I checked my assumptions using actual forex data, and found that my hunch is right, that gold in reality should not be hedged to other paper currency, in order to preserve gold's inflation protection capability. I think it is safe to say that there is a few thousand years of history to support the theory of using gold as an inflaton hedge against paper money's devaluation. I think it is also safe for me to say if i do a hundred more sample calculations, i will still get the same conclusion that to ensure gold's effectiveness as inflation protection, gold investment should not be currency hedged to US dollar. Having established this fact, and based on your replies, I have come to a new and 3rd point...
Gold is not considered a USD asset - this view will then not contradict my first 2 points above! I am going to verify that gold is not a USD asset. The 'hard asset' class, such as gems, cattles and houses, are not commonly considered as USD asset, hence, gold, being a hard asset, should not be considered as USD asset also. What are USD assets then? More accurately, USD assets refer to USD denominated 'paper contracts' perceived by people to be worthed certain amout of paper money. Some commonly recognized USD assets are U.S. company shares and U.S. Treasury bonds, denominated in USD. Such bonds and shares, belongs to the 'paper assets' class. The fundamental difference between 'hard asset' gold and 'paper asset' shares is this: 'hard asset' gold, gems, houses, cattles will still continue to physically exist and represent value to people even if the prevailing currency suddenly disappears; on the other hand, if a currency disappears, the shares and bonds based on the currency can likely be practically declared worthless overnight.
Need a semi-hypothetical example? If not, skip this paragraph. Imagine during the occupaton of Singapore in World War II, the occupiers created the 'banana money' currency and banned all other pre-existing currencies. Imagine during the occupation, one gram of gold could have initially equaled 10 dollar banana money. Person A is holding onto one gram of gold and person B is holding on to 10 dollars of shares and bonds issued in banana money. Through time, the occupiers simply printed more banana money when they needed it. The subsequent large increase in amount of banana money in circulation causes hyperinflation and severe depreciation of banana money. Before the inflation, Person A's one gram of gold can buy 100 loaves of bread; after hyperinflation, prices of gold and bread rocketed up very sharply, so relatively speaking, one gram of gold can still exchange for 100 loaves of bread, give or take a bit. For person B, before the inflation, 10 dollars of shares and bonds in banana money can be exchanged for 100 loaves of bread; after hyperinflation and severe currency depreciation, 10 dollars of shares and bonds in banana money can now be exchanged for ony two loaves of bread... and if this is not bad enough... After the occupiers eventually lost and surrended and left Singapore, the banana currency became worthless quickly, and person B's 10 dollar shares and bonds denominated in banana money are now worthed practically nothing...
(The currency was also referred informally, and with more than a trace of contempt, as banana money, named as such because of the motifs of banana trees on 10 dollar banknotes)
Conclusion: Gold is not a USD asset. This misconception about gold being a USD asset is due to popularity of seeing gold price being reported in USD, causing non U.S. people to subconciously think that gold is similar to U.S. shares and bonds and classified as USD 'denominated' assets. Gold, being a 'hard' currency itself, has no USD currency risk because gold's intrinsic value for exchange of other goods is not 'risked' by any devaluation or destruction of U.S. dollars (or any other 'paper' currencies). In contrast, A Singaporean who owns 'paper' assets like U.S. stocks and bonds, are exposed to the currency 'risk' that USD may one day 'devalue' greatly against SGD and cause severe investment losses, or their USD investment may be unconvertable back to SGD if U.S. government one day declares that Singapore cannot transact with U.S. dollars anymore.
Finally, here is one of my favourite quote:
~Sherlock Holmes:
"When you have eliminated all which is impossible, then whatever remains, however improbable, must be the truth."
Last edited by Coearth on Mon Sep 10, 2012 2:07 pm, edited 1 time in total.
Re: Gold's currency neutrality and investing
A few quick thoughts, since I'm in the same boat as you, except in Canada. I would advise against a currency hedge since this means you are now betting against the USD, rather than betting against your local currency. Plus currency hedging is expensive and can create a 1% drag.
You want to look at gold priced in your local currency. There is nothing special about gold priced in USD, other than being convenient (although maybe it's important at the central bank level
). When I buy gold I don't have to convert Canadian dollars to USD's, I simply pay for the gold priced in Canadian dollars from a Canadian dealer.
Have a look at this kitco page where is has gold priced in various currencies:
http://www.kitco.com/gold_currency/inde ... erChart=no
Also I think Clive posted a nice chart that compared gold priced in various currencies, but I'm not sure where he put it.
You want to look at gold priced in your local currency. There is nothing special about gold priced in USD, other than being convenient (although maybe it's important at the central bank level
). When I buy gold I don't have to convert Canadian dollars to USD's, I simply pay for the gold priced in Canadian dollars from a Canadian dealer.Have a look at this kitco page where is has gold priced in various currencies:
http://www.kitco.com/gold_currency/inde ... erChart=no
Also I think Clive posted a nice chart that compared gold priced in various currencies, but I'm not sure where he put it.
Re: Gold's currency neutrality and investing
I totally agree that i should look at gold price in terms of local currency, and I should not do currency hedge with gold at all.Gosso wrote: A few quick thoughts, since I'm in the same boat as you, except in Canada. I would advise against a currency hedge since this means you are now betting against the USD, rather than betting against your local currency. Plus currency hedging is expensive and can create a 1% drag.
You want to look at gold priced in your local currency. There is nothing special about gold priced in USD, other than being convenient (although maybe it's important at the central bank level
Have a look at this kitco page where is has gold priced in various currencies:
http://www.kitco.com/gold_currency/inde ... erChart=no
Also I think Clive posted a nice chart that compared gold priced in various currencies, but I'm not sure where he put it.
I updated the 2nd post with my own reply about describing gold's currency neutrality.
Re: Gold's currency neutrality and investing
There she is. Thanks.Clive wrote: Was the one you were thinking of this one?