For quite a while Capital Economics have been bears on gold. As of this week that has changed, with the consultancy now forecasting that the pretty yellow metal could reach $2,000. Mind you, contrarians argue that the time to buy is when the most bullish of investors has turned bearish, and the time to sell is when bears turn to bulls. So, will gold really keep on rising?

The truth is, gold is a classic bubble product. George Soros has said as much, calling the gold boom the “ultimate asset bubble”. It is a classic bubble commodity for the simple fact it goes up for no reason other than that it always does in times of insecurity.

Gold is not like oil, which is driven by economic fundamentals. Oil goes up in price because demand for energy rises while supply is limited. Gold rises because people believe in it, but they believe in it for no reason other than that people always have.

That’s why Keynes once called it a “barbarous relic”, and why Warren Buffett was once moved to say of gold: “It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

And for those reasons, economists have never been that fond of gold. Gold production does not help us produce more, it doesn’t make the world wealthier. As King Midas found out, you can’t eat gold, and you certainly don’t want to find that everything you touch turns to gold.

Peter Bernstein, the late economics historian, said in his book, The Power of Gold, that you can fit all of the world’s gold supply into an oil tanker.

Warren Buffett said that all that gold would fit into a container 67 feet or so across, and yet it would be enough to buy all the farm land in America, ten lots of Exxon Mobiles, and still leave you $1 trillion worth of change.
And what would you rather have, enough land and oil to supply the needs of a big chunk of the human race, or a pile of metal that isn’t good for much other than pretty jewellery?

Economists also don’t like gold because as a means of defining money, it has one fatal flaw. The supply of gold is entirely unrelated to the global economy’s productive capacity of goods and services. A global economy that links the money supply to the supply of gold, is one that can not realise the potential in new innovation. Unless, that is, by chance there is a new discovery of gold.
So the discovery of gold in the New World may have paved the way to the Industrial Revolution – although it created hyperinflation in Spain and Portugal during the hundred years or so after the conquistadores.

And yet gold rises because we have learnt in times of trouble it always does. Why buy gold? – because it is gold.

So the euro, dollar, pound and yen are in a race to the bottom. China doesn’t want to play ball. So gold rises.

Others fear that all this quantitative easing will lead to hyperinflation, so gold rises.

Others say we may get deflation, so gold rises.

In other words, a gold bull may say: “The answer is gold. Now, what’s the question.”

If the powers that be that run the global economy have any sense, then they absolutely will not enter into a new gold-based currency standard. We suspect the fears of both hyperinflation and deflation are overdone.

Capital Economics argues that in real terms gold is still below its all-time high, that the price of gold in ounces is approximately 15 times greater than the price of oil in barrels. But the average since 1970 has been 16.

But so what. Why has the average gold-oil ratio been 16 since 1970? There is no good reason. Besides, the gold-oil ratio could equally be implying that oil is too expensive.

Economists put too much emphasis on the relationship between prices in the past. They don’t take into account the forces of randomness, and how we can then be influenced by random forces to think we have seen a relationship, which in turn influences our behaviour and for a while can indeed create a relationship between two indices. Until, that is, fundamentals come into play and we see a crash.

To our way of thinking, gold has bubble written all over it, and the boom in gold is irrational. But then so too was the last gold boom, and yet it made a lot of people very rich. And as Keynes once said: “The markets will remain irrational longer than you can stay solvent.”

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