Gold: now the world’s hottest fiat commodity

GOLD just keeps going up. And the ways in which investors can buy it are becoming increasingly varied. This week, Deutsche Borse Commodities launched a new form of exchange-traded security that is essentially a certificate of ownership for a chunk of allocated gold. In a signal of how much demand they expect, the firm has reserved €1.6bn worth of gold for the purpose.

Meanwhile, iShares’ main physically backed gold exchange-traded note now stands at over $4bn in total net assets and data from the World Gold Council shows that investor (as opposed to industrial) demand now accounts for 38 per cent of gold demand, versus 19 per cent in 2007.

But despite the exponential rise and rise of gold prices, not everyone is taking long positions. A solid core of investors sees gold’s long rally as an irrational and dangerous phenomenon that will end in tears. Courtiers Investment Services’ chief investment officer, Gary Reynolds, for example, is mulling taking a short position. In a research note, he writes: “In the absence of the rapid increase in demand for gold as an investment, the price would be significantly lower. The whole process is bizarre.”

What he means is that demand for gold for purposes other than locking bars in vaults has actually decreased. Between 2007 and 2009, for example, the amount of gold in demand due to electronics, industrial uses and jewellery declined from over 450m tonnes to around 360m tonnes. Over the same period, its price climbed from $600 per ounce to $900 per ounce.

Analysts at FxPro point out that this jump is exaggerated by the dollar’s weakening. For example, between March 2009 (the US’s first round of QE) and today, gold is up 40 per cent in dollars. But, they point out: “When priced in a weighted basket of non-US currencies, gold is up only 20 per cent. So the gold price tells you just as much about the dollar as it does about the demand for gold itself.”

Even so, gold is at historic highs. Castlestone Management’s Connor Noonan says the movement is being driven by growing money supply and a currency devaluation war: “The catalysts for big rallies are all coming from the same thing: central banks. Until banks start to let their currencies rise, ending the forex race to the bottom, I see no reason to move out of gold.”

But there is a major difference between the latest gold rush and past instances: this time, gold bugs are buying through exchange-traded products. Such products now account for nearly half of investment demand for gold and, crucially, they enable speculators to move in and out in a flash.

This means that when the gold crash comes, it will all happen at lightning speed. Reynolds writes: “Gold bulls cite the lack of confidence in fiat currencies as a motivation for the price rise. ‘Fiat’ is used to describe anything that has no intrinsic value apart from that which is placed on it by society. This clearly applies to all paper money, but it also applies to gold.” Ironically, when the crash comes, it could be those in liquid products they can exit quickly who will be safer than those with bars stored under their mattress.

Going long is nonetheless a fairly safe bet for as long as the money supply keeps expanding, but with the consensus that UK interest rates will go up late next year, the currency wars could end sooner than you think. And when that happens, goldbugs who are too slow could find they have been chasing a very costly wild goose.