So, the gold bug still bugs you
KEYNES called it a “barbaric relic” in 1924. Scarce, attractive, malleable and immune to corrosion – gold used to be ideal money before the advent of modern paper money. Today, just like diamonds, gold is also a girl’s best friend.
In Asia, it is the masses’ darling. Most Asians are showered with gold when they are born; gold is figuratively given away during Chinese New Year; blessed with it when they get married; and even when they die – gold paper is burnt to accompany them to wherever. Money aside, gold plays an important part in the social lives of most people in Asia.
Monetary gold
Britain went off the gold standard in September 1931 in the midst of the Great Depression (1929-32). Two groups of European “gold bloc” nations (including Germany and France) held on and did not abandon the gold link until 1936.
By then, rigid adherence to the gold standard had made the Depression worse. Between 1934 and 1940, some US$16bil of gold flowed into the US, giving it ¾’s of global official gold holdings. By the end of World War II (WWII), it was clear that the US dollar was as good as gold. Indeed, it was even better since US dollar holdings earned a regular return.
After WWII, the Bretton woods system was put into place. The original system worked well for 25 years mainly because the US dollar was convertible into gold at a fixed price (US$35 an ounce). The International Monetary Fund (IMF) served as administrator for this gold-anchored monetary system of fixed (but adjustable) exchange rates among currencies.
However, in August 1971, President Nixon closed the vestigial gold window and the world off this gold-exchange standard. So, for the past 38 years, the world has been engaged in an experimental monetary system based essentially on a single reserve (the US dollar) with no link to gold.
This new arrangement of flexible (and managed) exchange rates worked flauntingly in the early years of the 1970s; and passably well in the next two decades.
Lately, however, the dollar exchange standard has been blamed for everything from promoting global imbalances to the recent economic crisis – and a future of rampant inflation yet to come. For more, read my Aug 8, 2009 column, “The Dollar Quagmire”.
The gold bugs are having a field day since. A Canadian gold-watcher friend talks enthusiastically of “gold being the only currency central banks can’t print” and “gold as an attractive new pillar of the global monetary system since it is not beholden to national politics, nor dependent on the whims of any central bank.”
World running out of gold?
The continuing interest in gold by commodity investors, central bankers, savers, speculators and consumers make it unique among commodities. Indeed, contrary to recent talk of “peak gold”, the world is not running out of gold.
Rising prices and faltering mines do not imply scarcity. Gold is constantly mined, bought, held and sold. Every year, over four times as much gold is mined and over twice as much recycled as is needed by industry.
Contrast this with say, oil. Annual crude oil supply more or less matches demand. Global oil stockpiles satisfy up to 40 days of crude demand.
The World Gold Council estimates that gold above ground today amounts to 163,000 tonnes, which would last 375 years, or nearly 3,000 times longer. Of this, holdings by central banks, IMF and governments (i.e. monetary gold) aggregated about 25,000 tonnes (15% of global) of which, the largest hoard is in the US – 8,100 tonnes. China, the world’s largest gold producer, holds only 1,054 tonnes (up 76% since 2003).
Even so, the very threat of any scarcity triggers off substitution. The 1970 price spike boosted porcelain in dentistry. Jewellery demand may possibly be more price inelastic.
But that’s also a matter of fashion, as recent slide in sales suggests. What’s more, psychology rather than supply and demand, remains critical.
Man’s addiction to gold
Gold and its mystique are deeply rooted in our human psyche. What’s clear is the absence of any rationale to tie money to gold; it is an anachronism of our modern world. Why hold gold then?
The context is revealing. The US$1 bill (its current basic design was from 1957) has since lost 87% of its purchasing power against the US consumer price index-CPI (average annual rate of 4%, as against 2% in Europe).
According to Harvard economic historian Prof Neil Ferguson, if you exchanged US$1,000 of savings for gold before the window was slammed shut in 1971, you would have received 26.6 troy oz of gold. Sold at even US$1,000/oz, the savings would have been worth US$26,596 today! But that’s history.
Is gold a good store of value? No. On the surface, it seems so. Look at the facts. In 1980, gold price was US$400. By 1990, the US CPI had risen more than 60% but the gold price stayed at US$400.
By 2000, the gold price fell back to US$300, while the CPI more than doubled! Even when the gold price peaked to US$850 in 2008, it fell back quickly in the face of falling demand.
So, over 20 years, gold prices had failed to keep up with the rise in CPI. When investors are scared – about inflation, political turmoil, financial crises, deflation – they run for cover to gold. Its price trend has been tracked and labelled the “index of anxiety.” But, clear as day, when things calm down, gold price always retracts.
Is gold a good hedge against the weak US dollar? Again, no. History shows gold does not hold its value against the euro or yen when the US dollar depreciates.
In 1980, US$1=200 yen. And, 25 years later, US$1=110 yen. The price of gold had remained during this period at about the 1980 level, i.e. US$400. So holding gold did not offset the fall in the value of the US dollar.
Surely, there is more to just “flight to safety” in gold. Recent experience shows that gold had performed well. Admittedly, gold is no slouch; it can have legs. But the future is changing.
In 2009, the gold price averaged US$972, 10% higher than what the London Bullion Market Association (LBMA) analysts and traders had predicted early in 2009.
The median forecast for 2010 is an average US$1,100. Gold reached a record US$1,226 on Dec 3, 2009 – best ever since 1948; by year end, it was US$1,096.2. Gold stood at US$1,121 when I last checked. So gold did have a good run in 2009 – up by about 35% to its all time high.
Is gold looking less barbaric?
Several reasons account for the bullion’s price rally. They also suggest gold to be a high risk and highly volatile investment as an asset class with other commodities.
First, there has been (and still is) unprecedented investor interest, prompted by continuing uncertainties of all sorts, including doubts about the US dollar’s long-term role as a reserve currency.
Second, the shift by many central banks to be net buyers of gold (net sellers since 1988). Recent buying by China and India excites the market.
Third, worries that continuing government stimuli to counter the credit crunch could well be inflating another round of asset price bubble. I already hear LBMA traders complaining that gold is trading above “fair value”, as reflected by the current state of the fragile and anaemic global economy.
Fourth, rising sovereign risk (Dubai, Greece, Ireland and Spain) is raising doubts about the political will of the US and European governments in putting a credible back-stop on the “too-big-to-save” financial system.
Fifth, rapid changes have taken place in the mechanics of investing in gold (including more complex modes of investing in gold mining stocks and exchange-traded funds – ETFs) to effectively own gold without the hassle of actually owning physical gold.
Sixth, there is the ever present herding behaviour and “momentum trading” by ever bullish traders, reaching for new highs. Overhanging the market is the unravelling of the US dollar funded carry-trade.
Finally, instability of the current gold-free international monetary system poses new risks of price volatility that cannot be readily identified nor easily explained.
Last year’s financial implosion had led to great loss of confidence in paper assets. There is now a definite shift to holding tangible assets.
Gold’s uncertain future
I don’t see how gold can become a really attractive investment. Over its very long run since 1971, the yield on gold averaged 2% annually. Stocks were up 8% per annum by contrast. I do know some who look at buying gold as an insurance policy. As I see it, investors in gold are in it for the excitement of making money. The recent increasing involvement of commodity traders and private investors in gold points to continuing volatility and speculation.
So, expect boom-and-bust-like movements in gold prices. The new players providing any element of stability are the rich emerging countries’ central banks, that are essentially long-term players. If nothing else, they have staying power. The IMF will remain, in the short run, at least – a net seller through its limited gold sales programme (403.3 tonnes).
In the end, I share the views of my Harvard mentor Martin Feldstein and the ever pessimistic Columbia Prof Nouriel Roubini that gold is just not a good hedge, period.
It must be remembered that gold really has no intrinsic value. It is sterile. Hence, there is the ever present danger and risk of constant downside corrections. Indeed, I can see gold going back to previous peaks of US$750-US$800 with ease.
So if you want to hold some gold, there is no reason why you should do it in a rush – gold bug or not.
·Former banker, Dr Lin is a Harvard-educated economist and a British chartered scientist who now spends time promoting the public interest. Feedback is most welcome at starbizweek@thestar.com.my.
In Asia, it is the masses’ darling. Most Asians are showered with gold when they are born; gold is figuratively given away during Chinese New Year; blessed with it when they get married; and even when they die – gold paper is burnt to accompany them to wherever. Money aside, gold plays an important part in the social lives of most people in Asia.Monetary gold
Britain went off the gold standard in September 1931 in the midst of the Great Depression (1929-32). Two groups of European “gold bloc” nations (including Germany and France) held on and did not abandon the gold link until 1936.
By then, rigid adherence to the gold standard had made the Depression worse. Between 1934 and 1940, some US$16bil of gold flowed into the US, giving it ¾’s of global official gold holdings. By the end of World War II (WWII), it was clear that the US dollar was as good as gold. Indeed, it was even better since US dollar holdings earned a regular return.
After WWII, the Bretton woods system was put into place. The original system worked well for 25 years mainly because the US dollar was convertible into gold at a fixed price (US$35 an ounce). The International Monetary Fund (IMF) served as administrator for this gold-anchored monetary system of fixed (but adjustable) exchange rates among currencies.
However, in August 1971, President Nixon closed the vestigial gold window and the world off this gold-exchange standard. So, for the past 38 years, the world has been engaged in an experimental monetary system based essentially on a single reserve (the US dollar) with no link to gold.
This new arrangement of flexible (and managed) exchange rates worked flauntingly in the early years of the 1970s; and passably well in the next two decades.
Lately, however, the dollar exchange standard has been blamed for everything from promoting global imbalances to the recent economic crisis – and a future of rampant inflation yet to come. For more, read my Aug 8, 2009 column, “The Dollar Quagmire”.
The gold bugs are having a field day since. A Canadian gold-watcher friend talks enthusiastically of “gold being the only currency central banks can’t print” and “gold as an attractive new pillar of the global monetary system since it is not beholden to national politics, nor dependent on the whims of any central bank.”
World running out of gold?
The continuing interest in gold by commodity investors, central bankers, savers, speculators and consumers make it unique among commodities. Indeed, contrary to recent talk of “peak gold”, the world is not running out of gold.
Rising prices and faltering mines do not imply scarcity. Gold is constantly mined, bought, held and sold. Every year, over four times as much gold is mined and over twice as much recycled as is needed by industry.
Contrast this with say, oil. Annual crude oil supply more or less matches demand. Global oil stockpiles satisfy up to 40 days of crude demand.
The World Gold Council estimates that gold above ground today amounts to 163,000 tonnes, which would last 375 years, or nearly 3,000 times longer. Of this, holdings by central banks, IMF and governments (i.e. monetary gold) aggregated about 25,000 tonnes (15% of global) of which, the largest hoard is in the US – 8,100 tonnes. China, the world’s largest gold producer, holds only 1,054 tonnes (up 76% since 2003).
Even so, the very threat of any scarcity triggers off substitution. The 1970 price spike boosted porcelain in dentistry. Jewellery demand may possibly be more price inelastic.
But that’s also a matter of fashion, as recent slide in sales suggests. What’s more, psychology rather than supply and demand, remains critical.
Man’s addiction to gold
Gold and its mystique are deeply rooted in our human psyche. What’s clear is the absence of any rationale to tie money to gold; it is an anachronism of our modern world. Why hold gold then?
The context is revealing. The US$1 bill (its current basic design was from 1957) has since lost 87% of its purchasing power against the US consumer price index-CPI (average annual rate of 4%, as against 2% in Europe).
According to Harvard economic historian Prof Neil Ferguson, if you exchanged US$1,000 of savings for gold before the window was slammed shut in 1971, you would have received 26.6 troy oz of gold. Sold at even US$1,000/oz, the savings would have been worth US$26,596 today! But that’s history.
Is gold a good store of value? No. On the surface, it seems so. Look at the facts. In 1980, gold price was US$400. By 1990, the US CPI had risen more than 60% but the gold price stayed at US$400.
By 2000, the gold price fell back to US$300, while the CPI more than doubled! Even when the gold price peaked to US$850 in 2008, it fell back quickly in the face of falling demand.
So, over 20 years, gold prices had failed to keep up with the rise in CPI. When investors are scared – about inflation, political turmoil, financial crises, deflation – they run for cover to gold. Its price trend has been tracked and labelled the “index of anxiety.” But, clear as day, when things calm down, gold price always retracts.
Is gold a good hedge against the weak US dollar? Again, no. History shows gold does not hold its value against the euro or yen when the US dollar depreciates.
In 1980, US$1=200 yen. And, 25 years later, US$1=110 yen. The price of gold had remained during this period at about the 1980 level, i.e. US$400. So holding gold did not offset the fall in the value of the US dollar.
Surely, there is more to just “flight to safety” in gold. Recent experience shows that gold had performed well. Admittedly, gold is no slouch; it can have legs. But the future is changing.
In 2009, the gold price averaged US$972, 10% higher than what the London Bullion Market Association (LBMA) analysts and traders had predicted early in 2009.
The median forecast for 2010 is an average US$1,100. Gold reached a record US$1,226 on Dec 3, 2009 – best ever since 1948; by year end, it was US$1,096.2. Gold stood at US$1,121 when I last checked. So gold did have a good run in 2009 – up by about 35% to its all time high.
Is gold looking less barbaric?
Several reasons account for the bullion’s price rally. They also suggest gold to be a high risk and highly volatile investment as an asset class with other commodities.
First, there has been (and still is) unprecedented investor interest, prompted by continuing uncertainties of all sorts, including doubts about the US dollar’s long-term role as a reserve currency.
Second, the shift by many central banks to be net buyers of gold (net sellers since 1988). Recent buying by China and India excites the market.
Third, worries that continuing government stimuli to counter the credit crunch could well be inflating another round of asset price bubble. I already hear LBMA traders complaining that gold is trading above “fair value”, as reflected by the current state of the fragile and anaemic global economy.
Fourth, rising sovereign risk (Dubai, Greece, Ireland and Spain) is raising doubts about the political will of the US and European governments in putting a credible back-stop on the “too-big-to-save” financial system.
Fifth, rapid changes have taken place in the mechanics of investing in gold (including more complex modes of investing in gold mining stocks and exchange-traded funds – ETFs) to effectively own gold without the hassle of actually owning physical gold.
Sixth, there is the ever present herding behaviour and “momentum trading” by ever bullish traders, reaching for new highs. Overhanging the market is the unravelling of the US dollar funded carry-trade.
Finally, instability of the current gold-free international monetary system poses new risks of price volatility that cannot be readily identified nor easily explained.
Last year’s financial implosion had led to great loss of confidence in paper assets. There is now a definite shift to holding tangible assets.
Gold’s uncertain future
I don’t see how gold can become a really attractive investment. Over its very long run since 1971, the yield on gold averaged 2% annually. Stocks were up 8% per annum by contrast. I do know some who look at buying gold as an insurance policy. As I see it, investors in gold are in it for the excitement of making money. The recent increasing involvement of commodity traders and private investors in gold points to continuing volatility and speculation.
So, expect boom-and-bust-like movements in gold prices. The new players providing any element of stability are the rich emerging countries’ central banks, that are essentially long-term players. If nothing else, they have staying power. The IMF will remain, in the short run, at least – a net seller through its limited gold sales programme (403.3 tonnes).
In the end, I share the views of my Harvard mentor Martin Feldstein and the ever pessimistic Columbia Prof Nouriel Roubini that gold is just not a good hedge, period.
It must be remembered that gold really has no intrinsic value. It is sterile. Hence, there is the ever present danger and risk of constant downside corrections. Indeed, I can see gold going back to previous peaks of US$750-US$800 with ease.
So if you want to hold some gold, there is no reason why you should do it in a rush – gold bug or not.
·Former banker, Dr Lin is a Harvard-educated economist and a British chartered scientist who now spends time promoting the public interest. Feedback is most welcome at starbizweek@thestar.com.my.
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