HomeAnalysisAll that glitters, is not gold

All that glitters, is not gold

THIS week Zimbabwe announced that it will be introducing gold coins as part of measures to anchor the free-falling Zimbabwean dollar. The set of measures were not as broad and impactful as those announced at the end of April. These collective measures follow a protracted free-fall in the Zimdollar, which to date, has pared by 69%.

The Zimdollar is now the world’s worst performing currency on a year-to-date scale. Consequently, Zimbabwe’s inflation at 191% as at May is the world’s highest.

These matrices point to an economic crisis and reflect higher levels of poverty, shrinking gross domestic product (GDP) from dollarisation levels, shrinking disposable incomes and poor service delivery.

Authorities in Zimbabwe have maintained since 2019, that economic fundamentals are in shape and that the weakening currency is behaviour induced.

Fiscal and monetary authorities point to speculation and lack of trust as the major drivers of the economic crisis. This article will focus on gold coins, looking at possible implications of their issuance. Gold coins are not a new phenomenon in monetary policy and their indulgence dates back to pre-medieval times.

How does gold coins preserve value?

It is not clear how authorities intend to achieve this objective. The most direct way would be for the government to sell gold coins for Zimdollars. That way, it would effectively and directly mop-up excess Zimdollars from the system and this is how it works.

The financial system in Zimbabwe is made up of local currency on the one hand and foreign currency on the other. The local currency has been losing value and is failing to store value, so people prefer to transact in hard currency.

Transacting in USD means the end of storing or preserving value, a function, which the Zimdollar has failed. Consequently, the demand for foreign currency is forever going up.

We will touch briefly on why the demand is ever up and why the Zimdollar value is falling, contrary to the behavioural notion peddled by the government.

Before we do that, let us complete the circuit on gold coins. When the government realises that demand for forex is going up; it is a reflection of a weakening currency. In conventional economics, the central bank has a set of tools it can play around with to influence currency stability.

There are open market operations, which are basically forms of money market instruments that it can issue and reduce the money supply levels of the local currency.

By rebalancing the market, the central bank will hope to achieve a local currency favourable equilibrium. These instruments include Treasury Bills and Non-negotiable Certificate of Deposits.

As they issue the papers at an interest rate to investors who largely include pension funds, banks and insurance companies, they receive actual money balances, which effectively reduces local currency liquidity in the system.

These instruments are supported by other measures such as adjustments of interest rate. In the latest monetary measures announced by the Reserve Bank of Zimbabwe (RBZ), the interest rate was raised from 80% to 200%. Increasing the interest rate reduces propensity to borrow, hence the aggregate liquidity levels.

However, this is dependent on inflation levels. As long as the interest rate is below the annual inflation rate, the window for speculative borrowing remains open.

Outside of this, government may also pursue moral persuasion to change citizens’ behaviour and attitude towards currency. However, it takes two to tango and government may have to create goodwill, through transparency and plugging corruption.

Over the years, government has used those other forms of intervention, particularly, TBs, NCDs and interest rate adjustments to control money supply growth. Gold coins are an interesting dynamic and first for Zimbabwe in its contemporary history.

Gold coins are supposed to be minted from actual gold after the precious mineral has been produced and sold to Fidelity Printers, on behalf of RBZ. Fidelity Printers will mint the coins.

Typically, the gold coin should contain the equivalent value it is sold for, which in turn is derived from global markets. The value or price of gold is determined on global metals exchanges such as the London Metal Exchange (LME).

These markets are driven by market forces of demand and supply which in turn are fundamentally determined. For example, gold peaked at US$2 074,88 per ounce in August 2020 and is currently trading at around US$1 800 per ounce.

The peak level of gold was reached at the height of Covid-19 and earlier this year, higher uncertainties following the Russia-Ukraine war and the rising inflation in the US and the rest of the world. These dynamics (uncertainty) favour a rally in the price of gold. Gold is seen as a safe haven asset in turbulent times.

However, in periods of sustained economic growth, investors prefer riskier assets, such as stocks.

Now in the context of Zimbabwe, the gold coins are coming in as a mechanism to cool off an overheating economy. Government is concerned at the rate at which citizens are dumping the local currency for USD.

The state views gold coins as a diversion which can possibly help redirect demand from USDs to gold. There was no clarity at the day the measures were announced, which currency the coins will be sold in, but we ran simulations on the option to determine possible outcomes.

In conclusion, we deduced that whichever route is taken, the coins will not achieve the intended results of currency stabilisation.

First, going by the pronouncement that the gold coins will be sold in USDs, presumably confirmed by the RBZ governor John Mangudya, it would follow that citizens with local currency will have to buy USDs to use in purchase of gold coins. There is no indication of why government thinks citizens will prefer the unknown gold coins instead of the straightforward USD currency.

Clearly, gold coins are unchartered waters for most citizens. There is absolutely nothing to show that what Zimbabweans need are investment alternatives. Rather, what is clear at this point is that citizens need a store of value and to achieve this, they are using the most liquid alternative, which is the USD.

Most Zimbabweans do not have the capacity to save for investment. Their indulgence to forex is only transitory as it facilitates settlement of key monthly bills such as rentals. Only bigger corporates have their balance sheets exposed, but even to them, the most viable alternative is keeping liquid cash in forex.

Some companies are beginning to report that foreign currency is now accounting for a good fraction of their revenues. This allows them to preserve their balance sheet to some extent. For their local currency exposure, companies would rather replenish stocks or invest in hard assets, cash flows allowing.

So what does this mean? The alternative to sell coins in USD is not a value proposition to most holders of USD. There is no incentive to hop on to gold coins since this is a complex world of fundamentals, which only technocrats may best understand.

As an analyst, I would not encourage investors to buy into gold over a mid-term horizon because gold is at a record high and the prevailing factors may change resulting in a decline in its price.

Gold rallies in periods of high uncertainty and weakens in periods of sustained economic growth.

We are currently in a period of high uncertainty given the Russia-Ukraine war and the fading Covid-19. So, buying gold now is tantamount to buying Bitcoin at US$63 000. There is a huge possibility of being burnt even if it means that investors have the capacity.

Investment is equally about timing. It may make sense to buy gold at levels of close to US$25 000 and not in the range of US$30 000.

  • Gwenzi is a financial analyst and MD of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — respect@equityaxis.net

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