Gold's Real Fundamentals
By Alen Mattich
Of DOW JONES NEWSWIRES
LONDON (Dow Jones)--Gold troubles me.
Last week the yellow metal hit a high at just under $650 an ounce for the first time since 1981. And its performance over recent months is showing every sign of being able to set a new record (nominal) high well above $800 if pundits like commodities guru Jim Rogers are to be believed.
But why should gold have become so favored now, having spent much of the past quarter of a century losing ground - only in recent months has a long established trading range finally been breached?
There are plenty of reasons offered by bulls.
Jim Grant, of the respected Grant's Interest Rate Observer investor newsletter, offers what's probably the best, albeit still shaky, justification. He says it's because gold is being sought out as a hedge against inflation.
In a world of what economists call "fiat" money - cash that can be called into existence by a central bank's printing presses, without reference to anything real - gold offers a reliable medium of exchange not subject to political whim.
The U.S. Federal Reserve has been the biggest, but by no means only, culprit in pumping the global economy with excess liquidity during the past couple of years. Only lately have U.S. interest rates come back to neutral levels, after dipping to a negative real rate in response to the bursting of the tech bubble and 9/11. The Bank of Japan has only just ended its zero rate policy and the European Central Bank's policy is still too lax.
This flood of money has lifted (almost) all boats in the asset markets - shares, commodities, and emerging market debt and equity. Gold has been a relative latecomer to the party, lagging a huge boom in industrial metals.
The recent exception to the story of universal boom has been sovereign debt. Bond yields have been climbing since the start of the year, with 10-year Treasuries, the global benchmark, offering more than 5% for the first time since mid-2002.
That seems to be a signal the market is worried that all that central bank money is finally starting to generate generalized (rather than just asset price) inflation. Which is where gold comes in. Investors, the story goes, have finally latched onto the world's best hedge against the debasement of their currencies.
So what's wrong with this story?
Official statistics have generally painted a rather benign inflationary backdrop - certainly in terms of core measures. Headline inflation has started to pick up, however, at least partly in response to rising commodity prices, particularly $70 oil.
The problem with the inflation story, however, is that gold hasn't been the best haven to protect yourself against inflation during the past quarter century. Even if you look at it following the price spike of the early 1980s (ie when it dropped back below $500), gold has consistently lost value in real terms and, during most of that time, in nominal terms as well. Gold's been a terrible hedge against inflation.
During the late 1980s, when the U.S. inflation rate was a percentage point and more what it was last year, the price of gold was below $500 an ounce.
What's more, anecdotal reports suggest that some of the biggest players in the gold market are hedge funds piling into the latest momentum play.
Wild volatility in the silver market - a doubling in prices over a year and a half and then a 20% pullback in the space of a couple of days - suggests that speculation is the real fundamental behind the gold market as well.
-By Alen Mattich, Dow Jones Newswires; 44-20-7842-9286; alen.mattich@dowjones.com
(Readers are invited to respond to Asset Class columns by e-mailing the columnist named at the end of each item or the Editor at market.beat@dowjones.com)
(END) Dow Jones Newswires
April 24, 2006 06:41 ET (10:41 GMT)
Copyright (c) 2006 Dow Jones & Company, Inc.
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