Shakespeare’s Prince of Morocco said that all that glistens is not gold. It seems that Shakespeare’s famous dictum applies to economics too, because, from an economic point of view, when the economy fails to glister, it is usually seen as time to buy gold.
A couple of years ago this column was a fan of gold. At the time it all seemed right. Sure, there was the speculative motive. Just like now, there were plenty of reasons to believe gold would come back in fashion as the dollar gradually lost its dominance.
But there were other factors. Two years ago, gold was in high demand because it is especially popular as an item of jewellery in India. As the Indian economy grew, so too did demand for that yellow metal.
It also has properties that make it especially useful as a conductor of electricity, which means it is used, albeit in tiny quantities, in semi conductors.
Sure enough, gold did indeed boom. Relative to the pound, it did especially well, for not only did the dollar price of gold shoot up from less than $600 in 2006 to over $900 by last year, at the same time the pound fell against the dollar.
So, if you had invested, say, £1,000 in gold on 12 September 2006, when there were 1.87 dollars to the pound and gold was going for $592.5, then today, with a dollar pound exchange rate of 1.4577 to the pound, and with gold at $900.8, your £1,000 would have risen in value to £1,950.
So, if you had bought gold at about the time when this column starting predicting it would rise, 30 months ago, you would have doubled your money.
But has gold now lost its lustre?
It is just that, once the economic crisis erupted onto the scene, a contradiction emerged.
On the one hand, there was good reason to buy gold, because gold does tend to do well in a crisis. But on the other hand, demand for gold for its practical and aesthetic benefits was diminishing. Some time ago, evidence suggested Indians had stopped buying the metal as it had become too expensive. As for its properties as a semi conductor – well, just like other commodities, you would expect demand for gold as a commodity having practical benefits to fall in a recession.
So at least two of the original three justifications for buying the metal have gone away.
Traditionally, gold is a seen as a hedge against inflation – but supposing the doves are right, and we get deflation? What would that mean for gold?
But there is anther factor pushing on gold. Supposing China chooses to begin replacing its dollar reserves with something else, and that something else is gold?
Since December 2002, China has held 600 metric tonnes of gold. But recently, the Chinese news agency Xinhua quoted the State Administration of Foreign Exchange as saying China’s gold reserves were now standing at 1,054 metric tonnes.
You can see why speculation has increased that China is set to become a major purchaser of gold.
It is just that, actually, the amounts involved are still quite modest. According to Capital Economics, China’s goldmines produced 288 metric tonnes of gold last year. Furthermore, even if it purchased all this extra gold at last year’s lowest price, it would only have spent $12.6bn, a tiny fraction of last year’s $419 billion worth of foreign currency reserves.
Besides, if you are diversifying into gold, it only makes sense to make your announcement after the event.
Capital Economics said: “There is no reason why Chinese gold purchases have to be negative for the dollar, especially as gold itself is typically priced and traded in dollars. At a stretch, Chinese diversification into gold might be seen as a vote of no confidence in the US currency. But there is nothing here to suggest that Beijing is about to start a major new trend. Indeed, the Chinese authorities’ track record as an investor is not necessarily one to follow – Beijing started to buy riskier assets in 2007, including shares in Western banks and private equity funds, and look what happened…”
The thing about gold is that there is no God-given reason why this metal should be the one that does well in a recession. The only reason why it does do well is because people expect it to.
If you believe the worst-case predictions for the global economy, that bad debts across the world will mount, forcing another banking crisis, while barriers to trade are erected, while swine flue runs amok across the world, then maybe gold will be the one commodity that does well.
Before we leave this topic, there is one more important thing to say about gold.
Many are now arguing that it is time to return to the gold standard. That only a return to gold can stop a return to hyperinflation.
Be in no doubt, a return to the gold standard would be a catastrophe. In an economy which sees a growing population and innovation creating the potential to produce more wealth, the last thing you want is a currency which is fixed to something arbitrary such as the availability of gold.
The only people who could possibly benefit from a return to the gold standard are those who already hold gold. The rest of us would be sent into poverty.
© Investment & Business News 2013