What a shame that Brown does not understand gold
Allister Heath says the price of gold will continue to rise, thanks to economic and political forces; a pity the Chancellor has not exploited this opportunity as cannily as the Chinese Real gold bugs don’t content themselves with demanding the return of the Gold Standard; they actually eat and drink the shiny yellow metal. An American economist I once knew took to drinking sake laced with gold-leaf shavings, of the kind served at Japanese weddings, to disprove the old motto that you cannot eat gold.
Cakes, sweets and even rice sprinkled with gold are all common in Asia, where it is thought that gold in small doses raises the body’s metabolism, helps blood circulate and is good for rheumatism. To the delight of investors, increased demand for gold for culinary and medical purposes from countries such as China and India is one reason that the precious metal has recently staged such an astonishing comeback on the world markets.
Gold was trading at about $680 (£365) an ounce at the beginning of the week, its highest price for 25 years, and it has undoubtedly much higher to go. It has been a truly remarkable turnaround. After hitting a record $850 an ounce in January 1980, the price of gold subsequently collapsed by more than two thirds and languished for more than 20 years before finally bouncing back.
Among the few in the City of London who accurately predicted both the timing and the extent of gold’s recovery were Bernard Connolly of Banque AIG, one of Britain’s most brilliant economists, and Clem Chambers, a charismatic entrepreneur who runs the ADVFN stocks and shares website. Chambers is forecasting gold at $1,000 an ounce, a level which looks more plausible by the day.
The rise, fall and rebirth of gold parallels the great social and political trends of our time. Gold almost invariably does well when societies and economies are in crisis or in times of war; it does badly in times of peace and prosperity. Gold’s inherent traditionalism and old-fashioned values, which makes it so appealing to investors in times of trouble, is exactly what repels them in boom times. With some important caveats, this remains true today.
In the postwar era, a time of austerity and reconstruction, traditional social restraints remained in place and gold retained a symbolic role at the heart of the monetary system. While the old Gold Standard never recovered from the Great Depression of the 1930s, the dollar was convertible into gold at a fixed rate of $35 per ounce under the Bretton Woods agreement; in turn, other currencies could be exchanged for greenbacks at a predetermined rate. When this system finally collapsed in 1973, gold’s last link with money was severed. Governments were liberated from their traditional restraints, allowing them to do as they wished with their currencies without needing to worry about maintaining gold reserves. For the first time in history, the global financial system no longer followed the old rules, just as many young people rejected traditional social mores.
At first this caused concern, especially as the 1970s saw a return to inflation of the most diabolical kind. The result was a shortlived spike in the price of gold. But by the late 1990s most investors had convinced themselves that central bankers, such as the Federal Reserve’s Alan Greenspan, had discovered the Holy Grail of economics: perpetual, inflation-free growth. Gold was passé; in an era of almost boundless optimism investors agreed with John Maynard Keynes, who argued that gold was an irrational, barbarous relic of a bygone era. They shunned gold, which is costly to hold and doesn’t pay interest or dividends, preferring instead to invest in shares.
By June 1999, at the height of the dotcom boom and irrational exuberance, the price of gold collapsed to a low of $252 an ounce. But far from fading away into irrelevance, as was widely expected at the time, it soon bounced back. After 9/11 the world lost some of its naivety. Now that Mahmoud Ahmadinejad, Iran’s President, seems intent on taking the Middle East to the brink of nuclear war, there is a real chance of a catastrophic shock to the world economy at some point in this decade. Growing fears of a new pandemic, a collapse in world trade talks or a popping of the global property bubble, as well as higher interest rates and energy prices, have convinced many investors that at least some of their assets should be allocated to safe havens — and that usually means gold.
But this time gold’s success is also in part a product of increased optimism in Asia, which has enjoyed astonishing economic success during the past decade. The continent’s new middle class is celebrating by splashing out on huge quantities of jewellery. Overall consumer demand for gold in India last year surged by 17 per cent in tonnage terms; in China consumers increased their purchases of gold by 8 per cent.
While a combination of Western pessimism and Eastern prosperity is pushing up demand for gold, supply is lagging badly. South Africa’s gold production hit its lowest level for 82 years last year because of mine closures. Although a number of new mines have come on stream in other countries, extraction in 2005 was only 1 per cent higher than in 2004, despite the massive increase in demand. The only reason the price of gold isn’t much higher is that central banks have continued to dump large amounts of it on to the markets; last year saw their highest ever gold sell-off and they now own less than a fifth of available gold.
One of those who spectacularly misunderstood the gold market was Chancellor Gordon Brown. Between 1999 and 2002 he ordered the Bank of England to sell 12.7 million ounces of gold, more than half its stock, at an average price of $275 an ounce, well under half today’s price. This decision has cost taxpayers close to £2.8 billion, the equivalent of one penny on the basic rate of income tax for a year. It will surprise no one to learn that while Britain was selling gold at the worst possible time, the Chinese, who understand markets far better than Mr Brown, were buying. The Chinese central bank snapped up 6.4 million ounces of gold in 2001 and 2002 and has more than doubled its money.
An investor who bought bullion four years ago would have made a return of 147 per cent. But even after such amazing gains, gold remains ridiculously cheap. This is because a dollar today buys much less than a dollar did in 1981, but gold is worth the same now as it was then. Over the past 25 years the price of goods and services in the US has gone up by 119 per cent. Merely to have kept up with inflation, therefore, an ounce of gold would have to be worth roughly $1,300 today. Far from being expensive, gold is trading at half its price of 25 years ago in real terms, at a time when the price of many other valuables, such as shares and property, has gone up many times.
Another reason to expect further gains for gold is that it has a very strong inverse relationship with the dollar: when the price of one goes up, that of the other almost invariably goes down. Because gold is denominated and traded in dollars, whenever the greenback falls in value against other currencies, as it is doing at present, buying gold jewellery or bullion as an investment becomes a far more attractive proposition.
The US and Asia have struck up an unprecedented deal: American consumers import Asian goods and export dollars; Asian central banks fund the US trade and budget deficits by recycling the dollars collected by their domestic producers into Treasury bonds. When the Asian central banks eventually tire of the stingy rates of return on their huge holdings of US debt, the dollar could slump further — and this is what the gold bulls are counting on. Growing inflationary pressures are also helping gold. Cheap credit and rock-bottom interest rates were the elixir chosen by Mr Greenspan and other central bankers to boost the global economy, first after the Long-Term Capital Management hedge fund went bust in the late 1990s, and then after 9/11. So far, this huge liquidity bubble has translated into too much money chasing too few homes, shares, bonds and commodities, pushing up their prices; but the pressure could soon move from assets to ordinary consumer prices. This is especially likely to happen if the price of oil and other commodities increases further, prompting worried investors to buy gold to protect themselves from renewed monetary chaos.
Today’s international economy may be doing well, but prosperity doesn’t feel as good as in previous booms, at least in the West. There is a bitter aftertaste; a nagging sense that terrorism and war are around the corner and that new technology can be used to destroy as well as to create. One need not be a gold bug or believe that gold holds the cure to cancer to see that the bulls are right. The price of gold will continue to rise, pushed up by powerful economic and political forces; the only question is how much higher it will go before peaking.
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