The trend is your friend, but only until it reverses
Yesterday I got an e-mail from a reader wondering why I hadn't picked up on recent reports from Japan about how ordinary people are rushing to sell their gold jewellery, sake cups and even their gold teeth as scrap in order to cash in on the record price of bullion.
Surely these stories can be taken as a clear signal that the gold market is close to its peak and about to crash, our reader implied.
'Come on Tom,' he exhorted me. 'I want to see a gold-bear article with some teeth.'
It's safe to say he was being sarcastic. This particular reader is a true believer in bullion. As the price of gold has climbed to new highs over the last few years he has e-mailed regularly to jeer at me for questioning the wisdom of treating gold as a valid investment.
Admittedly, after gold set a new high yesterday at US$1,913.50 an ounce, up 650 per cent over the last 12 years, it might look as if his jibes are justified.
But I'm standing by my view. As I wrote in this paper as long ago as May 2006, gold can be a great speculative trade, but it is a lousy investment.
The difference is crucial. According to the Oxford English Dictionary, an investment is 'some species of property from which an income or profit is expected to be derived in the ordinary course of trade or business'.
In contrast, the purpose of speculation is 'the chance of reaping a rapid advantage by a sudden rise in the market price of something which is bought merely in order to be held till it can be thus advantageously sold'.
In other words, an investment generates a regular yield. Speculators are out to make a fast buck.
In this sense, assets like bonds, which pay a coupon, stocks, which pay a dividend, and property, which generates rental income, all count as investments - even if current returns are miserably low.
But gold generates no yield, which makes it hard, if not impossible, to put a fundamental value on the stuff. As a result, when you buy gold you are simply making a bet that at some point in the future you will be able to sell out to someone prepared to pay a higher price for it than you did.
That's been a highly profitable bet in recent years, and anyone holding the metal now can congratulate themselves on riding a winning trend.
But that still doesn't mean gold is an attractive investment.
Sure, I know all the arguments about Asian demand for gold jewellery growing as incomes in the region rise.
But if you look at the data compiled by specialist consultancy GFMS, you will see that global jewellery demand has actually slumped by around a third over the last ten years as prices have risen.
What has grown - and what has driven the price upwards - is demand for gold as a purely financial investment, especially in the form of gold-backed funds.
That's got some observers worried that we may be witnessing a classic market bubble. And certainly, if you compare the percentage run-up in the gold price to previous investment bubbles like, say, the ones in the Japanese stock market in the 1980s or in Hong Kong stocks between 2003 and 2007, the similarities are unnerving, as the charts below show.
What's more, following the recent carnage in world markets, there are now plenty of assets out there more compelling than gold.
One of them is the stock market. John Wadle at Mirae Asset Securities points out that even if United States equities remain at their current depressed valuation, with earnings growing no faster than the trend rate of nominal US economic growth, then investors can expect to make capital gains of 210 per cent over the next 20 years.
To earn the same return from gold, the price of bullion would have to climb to US$5,900 an ounce. That would push the value of above-ground gold holdings to US$37 trillion, or 59 per cent of the world's gross domestic product last year.
'Gold is now a bubble compared to US blue chip stocks,' argues Wadle. 'The gold price is an absurdity waiting to correct.'
Such warnings won't bother the gold bulls, especially those like our sarcastic reader who've held bullion all the way up. For them the old traders' adage 'the trend is your friend' has never held so true.
Unfortunately, as our charts illustrate, such momentum-driven trends have an unfortunate habit of suddenly turning on their friends and baring their teeth.