The trouble with gold
with Tom Holland
An especially dedicated reader has written in to ridicule me for a column I wrote almost exactly a year ago.
At the time the price of gold was at a record high of US$1,195 an ounce, which prompted me to warn that: 'At these prices, speculating on gold is a high-risk trade.'
Yesterday, with gold at US$1,370 - a gain of almost 15 per cent over the 12-month interval - my correspondent was in a mood to jeer.
'Don't you at some point have to stand up and say you got it totally wrong?' he demanded, signing off 'ROTFLMAO', which stands for something like 'rolling on the floor laughing my ass off.'
It's a fair question. The answer is 'No'.
To see why, take a look at the first chart below. I issued the warning about the risk of buying gold on 26 November last year. Over the next week the price edged up by 2.6 per cent. But over the following couple of months, gold slumped back by just over 13 per cent.
Of course, the precious metal has since rallied handsomely But still, I think any trade that suffers a correction of more than 10 per cent in its first two months can fairly be described as 'high-risk'.
The trouble with gold as an investment is that it is impossible to come up with a fundamental value for the stuff. Other assets generate an income for their owners - bonds pay a coupon, stocks return a dividend, properties provide rent - which makes assessing their value relatively straightforward.
But gold returns nothing. It is in the same investment league as fine wines, Picasso sketches or hideous Qing vases. It is nothing but a bet on the direction of the market. Buying gold is speculation.
Even bullion market veterans recognise this. 'Gold is not a fundamental market,' admits Jonathan Spall, director of commodities at Barclays Capital and author of a 2009 book Investing in gold. 'The argument for buying gold is psychological and emotional, not economic.'
Yet I doubt my correspondent would be persuaded. He is one of those gold bulls who is buying the metal because they believe that the international banking system is insolvent, that the central bankers of the developed world are hell-bent on debasing their currencies, and that gold is the only secure refuge against the financial turmoil that must inevitably follow at some point in the future.
'Most so-called business journalists still don't understand monetary economics and are unable to join the dots connecting all the relevant pieces, most of which culminate in fear of counter-party risk,' he explains in his e-mail.
Unfortunately there is a problem with the idea that gold will be the only trustworthy store of value in a world where all the banks will be bust and in which paper assets will soon be worthless.
The trouble is that as far as most investors are concerned, gold is a paper asset. Few gold bulls these days actually own bars of the physical metal. Instead they own shares in exchange-traded funds, or ETFs, backed by holdings of bullion kept in secure vaults. The popularity of these ETFs has soared in recent years, with the amount of bullion they hold jumping more than five-fold over the last five years to some 2,087 tonnes, worth US$92 billion at current prices.
ETF owners think their money is safe. But as Simon Ogus, head of independent Hong Kong-based research company DSG Asia points out, the first thing that governments do when they get into the sort of monetary trouble that gold enthusiasts anticipate is to confiscate any private holdings of gold that they can find in the vaults of their countries' banks.
It's what US president Franklin Roosevelt did in the depths of the Great Depression in 1933 when he prohibited 'the hoarding of gold coin, gold bullion, and gold certificates' by US citizens. And it's what any number of past governments have done in one form or another when hard pressed for money. Some observers warn it could happen again, with ETF holdings the first to be seized.
Of course, gold enthusiasts could get around the problem by buying coins or bars and stashing them away under their mattresses. But purchasing physical gold is a painful experience. Buyers typically pay a premium of between 5 and 10 per cent over the spot price. And when they try to sell, investors find that dealers will only buy from them at a steep discount to the market price.
In all, gold owners take a bid-to-offer haircut of between 10 and 20 per cent. At spreads that wide, buying gold at any price looks like a risky trade.