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By Alan Kohler
February 23, 2009
So gold is now $US1000 an ounce again, or above $A1500. It was $US1000 last March, but the exchange rate was near parity then, so in Australian dollars that’s a rise of 50% in a year.
Anyway, a piece of metal about the size of your pinky fingernail can now buy 500 cappuccinos, a couple of decent suits, 50 BHP Billiton shares or a return ticket to Rome.
It is an interesting and beautiful metal, to be sure. It’s one of only three that has a colour other than grey or white (the others are caesium and copper); you can eat it; it’s extremely malleable while cold; and glints quite pleasantly in the sun when fastened to a finger.
The last time gold was at these sort of levels was in 1980, when it got as high as $US850 an ounce. In today’s dollars that’s about $US2500, so there is still some way to go to reach an all-time high in real terms.
And indeed there is no shortage of people predicting that gold is heading much higher in 2009 as it becomes increasingly popular as a “safe-haven” investment, along with US Government bonds and … err … well, actually that’s it. Gold and US Treasury bonds.
As a result, a dangerous bubble is developing in both of them. Bubbles have a nasty habit of lasting much longer than you expect, so while I think Eureka Report members need to be very careful about investing in gold, it clearly has not finished its current run, and bond yields have further to fall (that is, prices have further to rise) before the great expansion in supply of government debt kicks in and defeats the increase in demand.
The problem is simple, but pretty basic. In 1980 gold flew because of inflation; this time it’s because of a fear of deflation, apparently.
But there is no sign whatsoever of inflation, although there are plenty of dire warnings about it: no market indicators are forecasting a return of inflation and no serious economist is predicting inflation in anything other than the long term – as a maybe.
That’s because the immediate problem is deflation, caused by the near total insolvency of the world’s financial system. Investors are fleeing to gold because they don’t know where else to put their money: it is an irrational response to a financial panic.
The reason it is irrational is that there is nothing inherent in gold that will protect you from a deflationary spiral. Its investment value is entirely the result of either jewellery demand, or belief in its value.
In that it is no different to tulip bulbs in 1636. Tulip bulbs do have an inherent value because they result in very nice flowers coming up through the soil, but in 1636-37 there was an investment mania that pushed the price of a bulb to stratospheric levels based purely on a widespread belief in them as a store of investment value.
The Tulip Mania ended in February 1637, and now you can buy them online for $28.50 for 20 from Tesselaar’s Bulbs and Perennials, down from 4200 Dutch florins each at their peak.
In my view gold is the world’s most enduring mania. They were mining it and killing each other for it 14 centuries ago. The stuff has never been far from the avarice of men and any time things get sticky, up goes the price and men get that look in their eye again and stick in a vault with a brew-ha-ha.
Lately the buying is all through gold bullion exchange traded funds which, ironically – because gold is seen as an alternative to paper currencies – gives you a piece of paper instead of actual bullion, which is a headache to store. So the ETFs have to buy the stuff by the tonne, and can’t keep up with the cash inflow.
But here’s the thing: if gold is worth buying now, so are shares.
Let me explain. An extended global depression, associated with deflation and a general collapse of the global banking system, will also result in the collapse of demand for jewellery and an increase in sales by central banks to finance their liquidity support operations. Thus, the gold price falls.
It is true, as Marc Faber says, that at this stage the world’s central banks are all printing money like crazy and debauching their currencies. Since they are all doing it at once, all currencies are falling at once, which is why – goes the theory – the gold price is going up.
That’s because gold is the only “currency” of which more is not being printed at the moment.
That, at least, is the theory behind its rise. However you cannot go direct from deflation to inflation without an economic recovery in between. If we end up with high inflation in a few years because of all the money being printed, that is likely to be because the money printing worked and the global economy is on the mend.
Yes, it’s true that you can have stagflation – recession with inflation – but I can’t imagine how that would be good for the gold price.
In fact the last time that happened, in the early 1980s, the gold price collapsed. The price spiked in 1980 as inflation soared and by the end of 1981 had halved again as the global economy slipped into recession.
The gold price spike was one of the great buying opportunities for shares: it signalled the beginning of a 20-year bull market in the Dow Jones in which the 1987 crash and the 1990 recession were mere blips. That bull market ended in 2000 and since then there have been two brutal 50% US bear markets, the second of which is not yet over.
But still, with the prospect of a global financial collapse and deflation – not inflation – gold is $US1000.
Like all bubbles, this one no doubt has some distance to run, so if you’re still up for some investment excitement, get in for the trade. But don’t think it is sustainable unless there is a fundamental improvement in the demand for commodities.
In which case, buy 50 BHP Billiton shares instead of that little piece of edible metal.
