Gold prices hit a new high of more than $US1,921 an ounce this week, or rather a new 31 year peak, then fell by $US90 an ounce.
It then closed up 2.2% early Friday at $US1857 an ounce in a reminder that it is very volatile even when it’s very popular.
Gold is one asset that has come through recent turmoil pretty well. But why is it doing so well?
Is it a forewarning of inflation to come, or is it telling us something much more serious? Can it be sustained? AMP Capital Investors asks this week, Is it something investors should have in their portfolios?
Why the historical fascination with gold
Gold has long been a source of fascination for mankind.
The interest in gold dates back thousands of years to when advances in farming led to surplus food, and eventually the growth of prosperous civilisations.
Around this time gold became valued as a medium of exchange, as a store of value, and as a display of power and status.
Over the centuries it has acquired a status beyond its industrial use (which is now trivial) because it is attractive, malleable, ductile, resistant to corrosion, a conductor of heat and electricity, fungible, scarce and dense.
This range of properties has helped drive demand for it as jewellery, as a medium of exchange or money and as a store of value.
Today some see it as the only truly safe way to store wealth as it is highly liquid, portable, accepted globally and lacks any credit or counterparty risk.
Further, some see the decision to break the link between gold and paper currencies as being the undoing of the global economic system,
By contrast it’s seen by others as a barbarous relic with no real value beyond its beauty and use in jewellery.
A long term perspective
The chart below shows the price of gold since 1900 both in nominal and real terms.
Until the early 1970s, the US dollar was fixed against gold.
This was subject to periodic devaluations, such as in 1934. From the early 1970s to 1980 gold was in a secular upswing as investors turned to gold for protection against inflation.
However, from 1980 to 1999 gold was in a secular downtrend as inflation was brought under control.
This decade has seen gold enter another secular upswing in line with other commodities.
While the gold price has reached a new record high in nominal terms, in real terms it is yet to surpass its 1980 peak of $US2467 in today’s prices (albeit it was just a one week spike).
But it has been getting there fast.
What’s driving the gold price higher?
Gold has benefited from the general rise in commodity prices over the last decade, driven by rapid emerging world industrialisation, constrained commodity supply and a fall in the $US (which benefits commodities as they are mostly priced in US dollars).
However, a range of specific factors have also been at play in the case of gold:
First, some have been buying gold as a hedge against inflation on the basis that quantitative easing in the US and elsewhere (which involves using printed money to buy financial assets – notably government bonds) will generate higher consumer price inflation.
Second, gold is seen as a good alternative to major currencies which are at risk thanks to high public debt levels and quantitative easing.
While the focus has been on the US dollar, where the supply of dollars is increasing thanks to quantitative easing, the outlook for other major currencies is not much better.
Europe’s economy looks worse than the US and its debt problems are threatening to tear it apart.
The Bank of England looks likely to also engage in another round of quantitative easing.
The Bank of Japan is likely to intervene further to stop the Yen rising.
Switzerland is already doing the same. The Chinese Renminbi is not really an option as it’s not convertible and China is limiting its rate of appreciation.
This leaves the commodity currencies such as the $A (which is a separate story) and gold as potential safe havens.
Third, central banks in emerging countries are buyers of gold as part of a strategy to diversify their foreign exchange reserves away from the $US.
Fourth, fears of another financial meltdown on the back of European debt problems have increased, and some see gold as a hedge against this risk.
Finally
, the opportunity cost of holding gold versus cash or government bonds as an alternative store of value is continuing to collapse.
The Fed has signalled US interest rates will stay near zero into 2013, no increase is on the horizon in the UK and the ECB will likely cut its short term interest rates to near zero.
Government bond yields in developed countries are averaging around 2% or less.
So with cash and bond yields so low the missed income from holding a non-income producing asset like gold is very low.
Can it continue?
First, the negatives. After rising 34% year to date to $US1900 an ounce, gold has become technically overbought and due for a pullback.
Adding to the risk, investor interest in gold is very high – evident in net speculative positions in gold running at high levels, which is negative from a contrarian perspective. (Bear in mind speculative positions in gold have been high for two years and it hasn’t stopped the gold price rising to record highs.)
