The gold price is only half the equation. Britain is the other half.

It’s time to remind you of a painful truth. A boom in Britain’s economy could undermine the gold bull market. For British investors, at least.

That’s because the gold price is only half the equation for the British gold price. The exchange rate of the pound is the other half.

Back in 2017, I explained why in great detail. I called it the Gold Quadrants, because there are four possible environments for gold.

But before we get to that, let’s look at the proof. Because recent market action put it on display.

Below are four charts – gold measured in four different currencies over the past 12 months. The period I want you to focus on is the three and a half months from September 2019. That’s when the pound rallied about 12% against the US dollar – the currency in which the gold price is set.

Source: goldprice.org

The bottom left-hand chart is the British pound gold price. Between September and January, the GBP gold price fell. Priced in Japanese yen, the gold price held steady over the same time. In Aussie dollars, it barely fell. And in US dollars it fell a lot less.

By January, other currencies saw new highs in gold. The pound price was well off new highs until much more recently.

My point is, while Britain was in the midst of its Boris Boom, or Brexit Boom if you find that offensive, the gold price slumped for British investors.

This makes intuitive sense. Optimism and the gold price are not exactly closely related.

But my worry is that this price action bodes ill for anyone who is both a Boris or Brexit believer and a gold investor. Unless they’re planning on retiring overseas.

To explain all this properly, let’s turn to the Gold Quadrants I laid out in 2017…

The Gold Quadrants

The Gold Quadrants are the four possible outcomes when you invest in gold as a British investor. The gold price in US dollars can go up or down. And the exchange rate, which gives you the pound gold price, can go up or down too.

Two variables give you four possible outcomes.

Say the gold price in US dollars goes up 5% and the pound goes up 5% too. That leaves the UK gold price with no change. That’s because the gains in gold are cancelled out by the lower amount of pounds you get for your US dollars.

This is only one of four possibilities. I’ve put all four possibilities in this table — the Gold Quadrants Table.

It shows all four possible outcome for British investors. What I call “the four quadrants”.

The thing to understand is that these four quadrants are not equally likely to occur. Each one has a particular set of scenarios which will bring it about. Different combinations of money printing, GDP growth, inflation and everything else that can affect both the exchange rate and the gold price.

Gold and the pound tend to move together or in opposite directions depending on the environment we’re experiencing.

During a financial crisis, the US dollar surges against just about all currencies. That means a weaker pound against the dollar.  

Gold is a safe haven. It spikes when risks in the economy rise like in 2008.

This combination makes gold a brilliant investment for Brits because the currency move supercharges the gains from gold during a crisis – just when you want gold to perform. As Quadrant 2 explains above, you profit from the gold price and the exchange rate.

Compare this to what happens to an American gold investor in a crisis. Their dollar currency is a safe haven. The US dollar surges alongside the gold price during a crisis. This decreases the benefit of owning gold, as it cancels out some of the gains.

Usually, gold surges faster than the US dollar, making gold a good crisis hedge for Americans too. But far less beneficial than for Brits.

It’s not all good news

Now let’s take a look at the sort of environment that gives you the other three quadrants. These are less important to gold investors, as it’s during a crisis that gold really shines. But they’re still important as crises only come along every so often.

Quadrant 3 is the only quadrant where you definitely lose money. The gold price moves against you, as does the exchange rate. But the environment which would make this happen is not very likely to occur for long periods of time.

The pound would have to rally while the gold price falls. This implies deflation during a “risk on” investment cycle. That probably hasn’t happened for a sustained period since the Industrial Revolution when prices fell while British industry boomed.

The gold price is heavily influenced by inflation over time, which tends to go along with economic growth. And economic growth tends to be spurred by a falling pound, that’s why central banks try to keep it low.

To be clear though, such a move could happen in the short term, as both gold and exchange rates are volatile.

Quadrant 1 and 4 don’t offer a clear outcome. Your gains in the currency will offset your losses in gold, or vice versa. You might lose or make money as gold or the exchange rate outpace each other.

The point is that your investment is naturally held stable by the different directions of the pound and gold. Your gold investment experiences less price volatility than an American’s. That’s great for a safe haven which is waiting for a crisis to show its metal.

Does it really work like this?

The proof is in the pudding…

Take a look at the charts below. The gold price in US dollars has tumbled since 2013 while the fall in the pound allowed the UK gold price to recover since 2016:

Source: goldprice.org

This is an example of currency moves holding your gold steady in pounds – Quadrant 4. It’s not a bad result. But the real focus remains the supercharged gains during a crisis.

Gold versus Britain

That’s all from 2017’s article. Back to today.

In Quadrant 1, the gold price rises, as does the pound. That’s what I expect to happen in coming years as Britain performs well economically, pushing up the currency and gold performs well as everyone trashes their currency with more quantitative easing.

This makes the UK gold price uncertain. Which will rise more – the pound or gold?

If you believe, as I do, that gold’s gains will outpace the pound, you still need to be aware the currency would drag on those gains.

So, is it time for British investors to sell out of their gold?

Nope. There are other reasons to hold gold – it’s a form of true diversification. But I’ve written about that often enough.

My real message is that gold investors should be looking to get leverage to gold’s surge to offset the currency moves.

Gold miners are a great way to do so. Every increase in the gold price adds to their profits, making their stocks rise much faster than the gold price, theoretically at least.

For those British investors looking to profit from gold in a speculative way, gold stocks have become preferable to the commodity itself.

And our gold stock analyst is busy digging up the best ones for you.

Until next time,

Nick Hubble
Editor, Southbank Investment Research

Category: Commodities

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