• Fri
  • Dec 19, 2014
  • Updated: 10:15am
PUBLISHED : Wednesday, 20 March, 2013, 12:00am
UPDATED : Wednesday, 20 March, 2013, 4:27am

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

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.



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This article is now closed to comments

Well I agree.... but that will only happen when a decent politician with sounds economics knowledge decides that debt needs to be stopped at all cost... if not I will wait till the paper currencies around the world (USD, YEN, Euro, Pound) self destruct first than I will worry about a Gold Bubble.
Whoever believes any country in this world has any intention to pay down its debt is truly naive. Even so how can the Americans possible pay down its debt the honest way without devaluating its currency?
your colleague, Howard Winn, wrote a better perspective on how gold can appreciate due to the mispricing of risk caused by the central bankers.
When pro's such as Grant Williams, Kyle Bass, Jeremy Grantham and others educate us on what is really happening vs the news spin being feed to the general population, we have only ourselves to blame if we are not preparing in case the central bankers plan doesn't work out.
I don't like gold, but i have purchased gold as a value store until this mess clears up.
What is happening in Cyprus could be the canary in the coal mine. Unfortunately, it will only be obvious in hindsight. The fact you mention that it's been xx years, no blow ups doesn't mean it won't happen as none of the problems have been fixed (papered over w/ free money) and if it does, it will be fast once cross the tipping point.
I would expect you do a service to your readers by educating them, rather than tell them not to worry (which is the message I get from your article).


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