August 25, 2011 7:23 pm
A parable of gold bulls and bubble dynamics
By Peter Tasker
The parable of the talents contains a timely warning for the gold market. In the biblical story, the master distributes his wealth between three servants. The first and the second put their capital to work in businesses and generate healthy profits. The third, scared of losses, buries his share in the ground. The master praises his two active managers for their performance, but consigns the proto-gold bug to “outer darkness”.
In today’s world a lot of wealth is, in effect, being buried. All the gold mined is still in existence. At current prices it is worth about $8,000bn. This means the world is assigning around the same value to its store of this sterile, unusable asset as to the combined stock markets of Germany, China and Japan.
Gold’s recent dizzying ascent – swiftly followed by a sudden slide, as it fell $160 per ounce between Tuesday and Wednesday of this week – has been ascribed to loss of faith in the banking system, paper currency and also in the political leadership of the industrialised world.
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Fear is certainly a factor. When Ron Paul, a US libertarian politician and veteran critic of the Federal Reserve, disclosed recently that his top 10 equity holdings were all gold and silver mining stocks, the news reverberated around the blogosphere.
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According to the Gold and Silver Blog, “Ron Paul has taken steps to protect himself from the disastrous effects that Federal Reserve policies will ultimately have on the value of the US currency. The average American would be well advised to follow his lead.”
Fear is certainly a factor. When Ron Paul, a US libertarian politician and veteran critic of the Federal Reserve, disclosed recently that his top 10 equity holdings were all gold and silver mining stocks, the news reverberated around the blogosphere.
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According to the Gold and Silver Blog, “Ron Paul has taken steps to protect himself from the disastrous effects that Federal Reserve policies will ultimately have on the value of the US currency. The average American would be well advised to follow his lead.”
Gold is thinly traded and its supply constrained, so if people in the US did indeed pile into the market, the price could go much higher. But is gold a safe asset regardless of price?
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History suggests not. The last bull market in gold began in 1971 with US president Richard Nixon’s closing of the “gold window” and ended in a euphoric blow-out 10 years later. Buying gold in its last parabolic surge proved to be a disastrous decision as the yellow metal then entered a 20-year bear market in which its real price fell 80 per cent.
History suggests not. The last bull market in gold began in 1971 with US president Richard Nixon’s closing of the “gold window” and ended in a euphoric blow-out 10 years later. Buying gold in its last parabolic surge proved to be a disastrous decision as the yellow metal then entered a 20-year bear market in which its real price fell 80 per cent.
It is now 10 years since Gordon Brown’s sale of Bank of England gold reserves marked the bottom of the bear market. Since then, the gold price has risen sixfold. This is tamer than the 15-fold rise of the 1970s, but still equivalent to such notorious examples of stock market excess as the Nikkei index in the 1980s, Nasdaq in the 1990s and the Shanghai Composite in 2004-08.
Furthermore, the 1970s bull market in gold occurred at a time of raging inflation across the industrialised world and during a devastating bear market in government bonds.
The gold mania was just one aspect of a broader flight from financial to hard assets. This time, government bonds are in a bull market with yields at multi-decade lows, and the CRB commodities index is at 2006 levels.
The result of this dislocation is that in real terms this century’s bull market in gold already rivals the wild ride of the 1970s. So, why gold now? Why not protect yourself through stocks instead? After all, shares issued by a private-sector company are a kind of currency and their supply cannot be increased without stockholders’ say-so.
It can be argued that US stocks are not yet cheap, given the enormous gains clocked up in the 1980s and 1990s. True, but even so stocks are cheaper than gold. Since 1971, the S&P 500 index has risen 100 per cent in real terms, whereas the real gold price is 700 per cent higher.
Stock markets that have suffered serious corrections look better. Japan’s Topix index has only once before been cheaper than now relative to gold – in the 1980 blow-off phase of the last gold mania.
US house prices may be in a similar position. The Ofheo index of house prices is within 10 per cent of its 1980 lows relative to gold. A house can be lived in. Corporate stocks generate dividends. Gold generates nothing and therefore cannot be valued in its own right, only as a measure of revulsion towards other assets. Rather than being a store of value, it is doomed to obey bubble dynamics. When bubbles burst, they usually return to pre-bubble valuations. In 2001, gold was no higher in real terms than in 1972. A repeat would reduce gold bulls, like the third servant, to “weeping and gnashing of teeth”.
The writer is a Tokyo-based analyst at Arcus Research
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Copyright The Financial Times Limited 2011
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