Since the Bank of Japan joined the European Central Bank and Sweden in adopting negative interest rates at the end of January, the realisation that the US Federal Reserve could be next to follow this policy route has left UAE investors scratching their heads.
The dirham’s peg to the US dollar means that if the Fed adopted this policy, so too would the Emirates. Where would you put your cash if your bank started to charge you fees for holding your money rather than paying interest?
Of course, negative real interest rates are nothing new. In periods of much higher inflation real interest rates have often been negative, and quite strongly so. That is to say inflation was running at a higher rate than interest, so cash in a bank was losing its spending power in real terms.
Perhaps then we need to look back at those not so distant days for a clue as to what to do with money when it becomes more of a liability than an asset.
Basically this is the tipping point between hard and paper assets. Bonds pay you too little in interest and defaults are a big risk as certain countries and companies get into deep financial trouble. Equities tend to get into a lot of problems too because they first get overvalued as dividends drop with interest rates, and then profit gets hammered.
Bank stocks are a case in point. They have already fallen further this year than in 2009 during the global financial crisis. No investor can have missed the universally bearish sentiment in global stock markets right now.
On the other hand, hard assets will tend to rise in value. Take the humble domestic villa or apartment. If rented out, its income stream will look better than a negative interest rate. If owner-occupied it is a better place to have your cash invested than stuck losing value in a bank and mortgage rates will be very low.
The other hard asset favoured in the Emirates is gold. Dubai was the city of gold before oil came along. Some estimates suggest that 30 to 40 per cent of the world’s physical gold trade moves though the city today, but it is hard to say, as insiders estimate 80 per cent of gold transactions are not recorded.
Gold offers investors protection against negative interest rates because it costs nothing to hold in its physical form, although storage and insurance can add up unless you buy the exchange-traded products (ETPs) backed by physical gold, where the ownership cost is very low.
Incidentally, the tales about ETPs such as GLD not owning the gold they claim are ridiculous, as the physical gold is regularly audited and sits in a bank vault. It is certainly safer than burying gold in the garden and taking the risk of making somebody else suddenly rich. But be leery of websites offering gold deposits unless they have an exceptional track record.
Gold and silver are almost certainly the best options for investors in an era of negative interest rates, and that is why bullion has made double-digit gains since the new year. Bonds have also done well, but as dividend yields vanish this is not likely to continue. The bursting of the huge bond bubble is inevitable and perhaps not so far away now.
By contrast, precious metals are coming out of a multi-year correction phase and are currently very attractively priced for a rebound to the all-time highs of 2011. Even the supply of physical gold and silver is under pressure this year because of the shuttering of mines and exploration over the past four years.
Demand for gold and silver has been very strong, and this could quickly compound into a surge in prices after a classic double-bottom for the gold price last year and a clearly formed upwards trend this year, with a higher high for prices for the first time since they peaked at $1,923 in October 2011.
Gold always tends to perform best when investors are most pessimistic about other asset classes and central banks begin to panic and lose control. Deliberately choosing negative interest rates as a desperate last bid to stimulate economies is a step beyond quantitative easing or electronic money printing. Or look at the Bank of China choosing to devalue the yuan.
How high will gold prices go in such circumstances? Beyond the previous high of US$1,923 an ounce? Towards or beyond the $5,000 an ounce that 85 forecasters predicted back in 2010?
Maybe gold’s time has finally come.
Peter Cooper has been a senior business journalist in the Arabian Gulf for the past 20 years.
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