December 13, 2004


All that glisters (Buttonwood, Nov 30th 2004, The Economist)

It used to be that gold bugs touted the yellow metal’s credentials as a hedge against inflation. But the link was anyway pretty feeble, except for currencies with hyperinflation. And though consumer prices have risen a bit this year, it would be hard to make the case that inflation is about to roar anywhere in the developed world. Why, then, is gold prospering at a time when inflation is low? Perhaps it reflects nothing more than the fall in the dollar: gold transactions are denominated in dollars, and in euros the rise in the gold price has been anaemic.

However, there is no law that says a falling dollar must translate into a rising gold price. Apart from a rise in demand for jewellery, the rise in the price of gold may, at the margin, reflect demand for real, hard assets, as opposed to the paper sort. And the reasons are not hard to find, for across the developed world, debts have escalated alarmingly in recent years—and in America not least, hence the vast and growing current-account deficit. While central bankers are generally trusted not to “monetise” these debts by rolling the printing presses, history would suggest that this displays a touching naivety. As James Grant, publisher of an eponymous financial newsletter, and the most erudite of the gold bugs, says: “[Alan] Greenspan, the figurehead of the dollar, was trading at three times book in the late 1990s; I think he may return to book value.” Or lower.

Gold’s virtue, says Mr Grant, is that it is a monetary metal, because of its scarcity and, of course, its history. Actually, Buttonwood can’t help feeling, gold’s history counts against it. Of all the metals, the market for gold is probably the most rigged. It is because of history that central banks hold in their reserves almost a quarter of all the gold that has ever been mined. They would like to sell at least some of it, but the vast amount that they hold means doing so would drive the price down. In 1999, central banks therefore came to an agreement to restrict gold sales. The agreement—or cartel, if you will—was extended in September. But it would presumably be torn up if the gold price rose sharply: the Bank of France said this month that it wants to offload some 500 tonnes over the next five years.

And that would presumably limit gold’s upside.

The goldbugs and the French, perfect together.

Posted by Orrin Judd at December 13, 2004 5:01 AM

Gold, like any other commodity, will experience a price fall when suppliers or holders of gold see an opportunity to make a profit. It happened in 1660, and Spain is only now recovering from its bullionist folly, it happened in the late 70s as Bunker Hunt and pals can no doubt tell you, and it will happen again today.

Posted by: Bart at December 13, 2004 6:16 AM

"offload some 500 tonnes over the next five years"

"The goldbugs and the French, perfect together"

It would seem to the less sophisticated reader that Goldbugs and the French are on opposite sides of the market. In other words, the anti-goldbug (some on this blog) are one with the frogs.

Posted by: h-man at December 13, 2004 6:18 AM

Why, then, is gold prospering at a time when inflation is low?

It is the anticipation of future inflation.

You'll have to blame more than the French. Try the Indians and the Chinese, to boot. Or anyone with depreciating dollars on their hands that wants to preserve some value.

Posted by: Robert Duquette at December 13, 2004 10:36 AM

Bart Spain's problems were not sitting on gold. They spent every bit they could lay their hands on fighting wars in Europe and elsewhere. What cost hem so heavily was the political and social repression of the 16th and 17th centuries. Contrary to OJ the Inquisition was a Bad Thing, the price of which is only yet being amortized.

Posted by: Robert Schwartz at December 13, 2004 9:39 PM

I must disagree with both Bart and Mr. Schwartz. Spain's problem was that gold is money but it is not wealth. For the society that existed at that time, the massive importation of gold was no different than running modern currency printing presses. It greatly increased the amount of money circulating but added nothing to the actual wealth of the country. I partially agree with Mr. Schwartz that Spain's spending on wars was the direct cause, but that money was spent because the rulers thought Spain was much wealthier because of the gold, but in fact it wasn't.

Posted by: Annoying Old Guy at December 14, 2004 11:54 AM