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New arguments for gold sound like the old story warmed up
All that safe-haven buying may push the price of the precious metal higher and even to a record, but the bubble will eventually burst
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One tangential result of the sharp rise in risk aversion following the Cypriot debt crisis is that the price of gold has popped higher.
Yesterday, bullion was trading in Asia at US$1,601.86 an ounce, up 3 per cent over the past month.
You might think the latest price gain on the back of safe-haven buying can have done little to console gold's true believers.
Over the past 18 months, they have watched helplessly as the metal's price slumped, falling almost 20 per cent from its high of US$1,921.15, reached in September 2011.
But gold bulls are a hardy breed, not readily dismayed. The way they tell it, the market has just been taking a breather. Now, gold is poised for a fresh surge towards new - even more shining - record prices.
Enthusiasts point to several factors they say are combining to push prices higher.
Clearly, any crisis of confidence in the safety of European bank deposits after the continent's finance ministers ordered depositors in Cyprus to take a €5.8 billion haircut on their accounts will only burnish gold's standing as a safe-haven asset.
Then there is the mounting diplomatic friction in Asia, centred on North Korea's bellicose attitude and on China's territorial claims in the East and South China Seas, both of which should, say the bulls, encourage further safe-haven buying.
Next, there are supply constraints. Although demand for gold - both for jewellery and for investment - has grown strongly over the past 10 years, total world mine production has increased only 10 per cent since 2002.
Above all, however, gold bulls are heartened by what they see as the recent intensification of the currency wars being fought by the world's central banks.
Top warmonger is the US Federal Reserve, which last year embarked on its third round of quantitative easing, promising to print unlimited amounts of money in a bid to inject more life into the US economy and bring down unemployment.
With the Fed doing its best to debase the value of the US dollar, enthusiasts reason that the price of gold must rise in relative terms.
And with the Bank of Japan and the Bank of England joining in the money-printing race to the bottom, gold should appreciate against other major currencies too as other central banks try to diversify away from conventional reserve assets.
At first, it all sounds sensible enough, even compelling. Unfortunately, there are a few flaws in the reasoning.
First, neither the European debt crisis, diplomatic tensions in Asia, nor slowly growing mine production are new developments.
The European crisis is now well into its fourth year. Tensions between Asian neighbours flare periodically - North Korea's first nuclear test was in 2006, and there were anti-Japanese riots in China in 2005 - and then die down again. And tight production has been a feature of the gold market for years.
In other words, all three factors have been present over the past 18 months, during which the gold price slumped almost 20 per cent. If they didn't push prices to a new record then, it's hard to see why they should now.
There's still the quantitative easing argument. But there's a paradox here. If you believe that quantitative easing will succeed in revitalising economic activity, then the chances are you will conclude stocks are a more attractive investment than zero-yield assets like gold.
That's what happened last year, as investors bought into gold exchange-traded funds in anticipation of another round of quantitative easing, only to switch out of gold and into equities as they decided the policy might just work (see chart).
On the other hand, if you think that quantitative easing will fail, with all that newly printed money simply remaining on deposit at the central banks in the form of excess bank reserves, then there is little prospect of rising inflation lifting the price of gold.
In short, the arguments in favour of gold aren't as compelling as they seem at first.
That doesn't mean gold can't soar to a new record. But if it does, the only way it will get there will be on the back of a new momentum-driven trade, with investors piling into the market, afraid lest they miss out on rapidly accelerating gains.
In other words, it will be a bubble, which will inevitably burst, with the gold price falling back again - probably to about where it is now.