In 1931, as Great Britain crashed off the international gold standard, John Maynard Keynes was joyous. “There are few Englishmen who do not rejoice at the breaking of our gold fetters”, he wrote. Yesterday, Robert Zoellick, the head of the World Bank, an organisation that Keynes founded, seemed to be asking for the fetters back. He said that “markets are using gold as an alternative monetary asset” and that the metal should be considered as part of global financial reform. But while gold is very popular at the moment, its inherent value is largely mythical. Can the high price last?
Certainly gold has got a lot more expensive recently. After two decades of stagnation, the gold price started increasing at the start of the century. And when many asset prices fell in the recession, gold just kept going. Yesterday, pushed up by strong Indian demand during the Diwali festival, the spot price of gold passed both the $1,400 and the €1,000 level, both records. In real terms, the gold price is still considerably lower than it was at the height of the 1980 bubble, and so many think that there is space for further climbs.
Adrian Ash, a researcher at BullionVault, is unsurprisingly bullish. According to Ash, seasonal demand from Chinese and Indian households should continue to push up prices, with Chinese demand in particular likely to last. China deregulated its internal gold market in 2002 and 2005, and Chinese consumers have proven to have a voracious appetite for the precious metal. Ash says that Chinese investors will “keep hoovering the stuff up”, pushing prices up further.
Moreover, relatively few large investors have invested much in gold so far, meaning that demand could still grow an awful lot. As Ash puts it: “Investors are far more exposed to stories about gold than they are to actual gold”. If more start to see gold as an essential part of a portfolio, then that would push up prices too. Contracts for difference (CFD) traders might want to be bullish then.
But they also need to be careful. Paul Duncombe, Head of Multi-Asset Investment Solutions at Schroders, thinks that the gold price mostly reflects uncertainty, with quantitative easing in the US and global currency wars in particular unsettling many investors.
According to Duncombe, “people who worry buy gold – and at present many people are worried”. Traditionally, gold has been seen as a hedge mostly against inflation, but recently it has been used more as a particularly secure store of value at a time when global interest rates are effectively negative.
That means that if the global economy begins to pick up, and in particular if interest rates start to rise again, then gold may see a fairly dramatic fall in price, as investors unwind their gold holdings and move to assets that generate a return. The gold price has been increasing rapidly for a decade now, mostly thanks to very low interest rates. If expectations of the next decade change, then that could well reverse.
As investors who lost out in 1980 well know, the correction would probably be sharp and brutal. Duncombe points out, however, that very few people are expecting a change in economic conditions any time soon. Merrill Lynch doesn’t expect the gold price to fall below $1,400 until at least 2013, and only then to around $1,290. CFD traders should have plenty of time to make a profit then.
Despite Robert Zoellick’s comments, it is exceptionally unlikely that the world will ever return to anything resembling the gold standard. As the economic historian Barry Eichengreen has argued, the interwar gold standard failed because it was impossible to force surplus countries to adjust their real exchange rates, and so the burden fell onto deficit countries, like Britain, who had to deflate.
When the system began to fall apart, countries that adopted loose monetary policy did much better than countries that held onto gold, and we should expect the same to happen now. The expansion of credit should eventually lead to growth, though it may not be particularly balanced. When growth returns, the appeal of holding a useless metal instead of profitable investments will be a lot smaller. In the meantime, however, traders should profit while they can. In the long run, after all, we’re all dead.