Gold has been on a tear as of late, as investors lose faith in their governments and anticipate the return of inflation. But gold also serves as a form of “crisis insurance” – a role that could soon be more important than ever...

Earlier we talked about the rising tide of geopolitical risk in places like North Korea, Iran, and Israel.

For lack of space, we didn’t touch on further events unfolding in places like Afghanistan, Pakistan, Nigeria, Russia and Venezuela – all tied in to the global scheme of things by way of nuclear arms, oil supply, or both. 

There is at least one clear lesson to be taken from this rising drumbeat of ominous news: You want to have gold in your portfolio.

Gold and silver have been on a tear as of late (for reasons we’ve discussed at length in these pages, and will address in further detail soon). To give you the quick and dirty version, the yellow metal has been bid up as more traders and investors anticipate a loss of faith in government assets – and a coinciding return of inflation.

Where gold hasn’t gotten much respect, at least in recent months, is as a form of crisis insurance. Gold is not only the asset du jour in a time of rampant currency debasement... it’s also one of the last, best stores of value in a world gone mad.

Mr. Market, for his part, is a terrible predictor of geopolitical risk. The historical record shows that bonds and equities are happy to remain blithe and serene in the face of pending catastrophe, pressing as the situation might appear, right up until full-scale disaster hits. Then, when the unthinkable happens, the panic and the mayhem tends to appear all at once.

There are many factors that play into this occurrence, human nature not least among them. But in a nutshell, the pattern plays out over and over because Mr. Market simply does not know how to price low probability, high risk events. He is forever flummoxed by the low / high combo.

The low probability, high risk event – like the threat of war in the Middle East, for example, or the threat of North Korea’s collapse – is a sort of Gordian Knot that simply cannot be cut. And so, confronted with the unsolvable nature of the problem, Mr. Market, by and large, just shrugs... and ignores such events completely. (Until the day comes when he can no longer do so.)

The Pressing Logic of Crisis Insurance...

Having a growing roster of low probability, high risk geopolitical events on hand, then, is like filling up one’s garage with oily rags and rusty drums of kerosene. Thumbing one’s nose at the problem is like continuing to back the car into the garage, hot exhaust pipe and all, with no thought as to what might happen.

The general likelihood remains, of course, that nothing much at all will happen. But only a nut would be comfortable with such an arrangement. The risks are too serious to be ignored. 

That’s why gold makes so much sense from a crisis insurance standpoint for one’s portfolio – not unlike fire insurance for one’s home – as well as an inflation buffer and fiat currency debasement play. The world has oily rags stuffed in countless nooks and crannies now, and kerosene aplenty.

The funny thing is, if all the giant institutional players bought just a wee smidge of gold as crisis insurance to protect themselves – a mere handful of percentage points in the portfolio – the yellow metal would already be trading at many thousands of dollars per ounce.

...And a Puzzling Lack of Common Sense

The above leads to an obvious question. If it only makes sense to be protected rather than unprotected... and if one can be made immeasurably better off by owning at least a little gold (as opposed to none)... then why do so many “responsible” investors – and by this I mean large-scale institutional houses, pension funds, mutual fund managers and the like – still thumb their noses at the yellow metal?

There are plenty of tired reasons, but none that truly stand up. Gold is a “barbarous relic,” some say. (Gee, sure seems relevant to me, especially given what we just lived through.) Gold is “a lousy investment because it pays no interest,” others say. (Since when does one expect an insurance policy to pay interest?) The tragic scenarios “will never happen,” others scoff. (You mean just like AIG and Lehman Brothers could never in a million years have failed?)

Your humble editor suspects the reason more “responsible” investors have not latched on to gold is more prosaic. For the big institutionals, “responsible” roughly equates to “respectable.” And for those guys, buying gold is not yet the “respectable” thing to do.

In the world of institutions, hidebound tradition often matters more than logic or even common sense. Even though it would be viewed as lunacy not to have insurance on a million-dollar home, somehow it’s okay to be as exposed as the day is long with a billion-dollar portfolio.

That’s one of the dirty little secrets of Wall Street. We, the great unwashed masses who live our lives outside, are supposed to look up at the gleaming glass towers, the impressive academic credentials, the intimidating formulas and theories, and come away in awed silence. We are supposed to cultivate the impression that these institutional folks know exactly what they are doing... that all the scrolls have been unfurled… that upon these anointed ones hath been bestowed the privilege of no longer having to fly by the seat of their pants like the rest of us. 

Well, the Great Crash of 2008 put paid to that foolish notion. And now we can be even further certain these big-time institutional guys are goofballs, because so many of them don’t (yet) own at least a little gold. The way things are going, that is likely to change at some point. If the institutionals are forced to buy gold with both hands in due time, those could be very interesting days indeed.

There is still more depth to the geopolitical question – and a simple, powerful equation that governs the fates of great powers like China, Europe and the United States, as well as more obvious powder kegs like Pakistan, North Korea and Iran. We’ll get to that soon...

Other Related Topics: Gold Investments , Insurance Industry , Justice Litle , Safe Haven Investor , Silver Investment

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