Gold lacks lustre and is worth little more than the trinkets it makes

PUBLISHED : Tuesday, 20 September, 2005, 12:00am
UPDATED : Tuesday, 20 September, 2005, 12:00am

I AM NOT a gold bug and I have been wrong. Over the past four years, the price of gold has risen almost 80 per cent in US dollar terms and reached an 18-year high.

Among journalists I have almost as much egg on face for my gold call as the Economist magazine does for its big oil call in late 1998. Back then its editors took a break from their usual mission of warmongering and predicted that the price of oil would stay under US$10 a barrel for the foreseeable future.

The two are not unrelated. Gold is up in part because people seek an investment refuge in a time of worries that high oil prices will destabilise the world economy. Gold has traditionally served in this role.

But let us look at it a little more closely. Gold's value is rooted in the fact that it is lustrous, malleable and does not rust. These were rare properties thousands of years ago, particularly in combination, and deservedly made gold a precious metal.

But things have changed. Today, even the catch above the zipper on my trousers is lustrous, malleable and does not rust. Gold is no longer special. There is no longer such a thing as a precious metal. They are all just commodities.

But gold traditionally had one other thing going for it. Over thousands of years the new supply of it happened to rise in rough proportion to the growth of the economies that used it, and thus it served as a stable medium of exchange.

In simple terms, if you have an economy with 10 widgets and 10 ounces of gold, the price of one widget is one ounce of gold. If you have an economy with 100 widgets and 100 ounces of gold, then the price is still one widget per ounce of gold and you have price stability.

But that relationship between the supply of gold and the size of the economies that based their medium of exchange on it began to break down in the mid-19th century. First the availability of gold outstripped economic growth and then fell far behind it, to the extent that by the 1920s the relationship was under severe strain.

It broke after the second world war and finally snapped completely in 1973 when the United States government decided it would no longer fix a price for gold in its currency.

The fact of the matter now is that the only thing that protects the value of the US dollars you hold in your wallet (and Hong Kong dollars by extension) is your faith that the US government will not print too many of them.

And the only reason to believe that gold can still protect your wealth if the world's monetary system breaks down is that enough other people still believe it. This may be enough to drive up the price of gold at present but disillusion awaits all these believers if that breakdown ever happens.

Gold's day is past. Its properties are no longer unique, its real uses too few, its supply no longer a match for economic development and its present ownership too narrow for a medium of exchange.

If this is not enough to deter the believers, however, let me take another tack. One of gold's biggest drawbacks is that it provides you no interest payments, no dividends and no income yield of any sort. All that owning it really gives you is the cost of storing it and insuring it against theft. Thus for starters, if you are a long-term holder of gold, you have to think in terms of what value it gives you after inflation. The first chart sets this into perspective. The red line gives you the price of gold over the past 20 years. The blue line shows you what that would be worth in buying power after deflating by the US consumer price index. You lose.

What if you did something else with the money in 1985 other than buy gold? Put $100 into the Hang Seng Index and you would now have $2,250 after reinvesting dividends. Put the $100 into 10-year US treasuries, reinvesting the yield, and you would have $367. Put it into gold and you would only have $149 - considerably less after vault charges.

This, by the way, is if you think in US dollar terms. That rising US dollar price of gold would have given you virtually nothing over the past three years if you were a euro or Australian dollar investor.

I remain an unbeliever.