Outlook - Gold has lost the ring of confidence
It was originally in the 1930s that John Maynard Keynes described gold as a "barbarous relic". Central bankers and governments have taken their time in coming round to this point of view, but yesterday's announcement from the Treasury that it will be ditching more than half of Britain's gold reserves over the next five years seems to be the final nail in the coffin for gold as a monetary instrument.
In the markets, it is thought of as pretty much inevitable that the US, Germany and France will follow suit, probably rather sooner than later.
You can argue about the timing of the Treasury's decision, with the gold price at close to its twenty year low and with the IMF, Switzerland, Canada and Belgium all engaged in similar gold sales programmes. You can also argue about the manner of it - a publicly declared intention of sale which cannot but help drive down the price against the British taxpayer.
But the underlying logic is hard to fault. Gold has little if any place as a monetary instrument in today's world of massive electronic capital flows. It is costly to keep and move, and in any case, hardly anyone settles their international obligations in the stuff any longer.
Ah but the feel of it, the look of it, the mythology of the metal - as ancient and primeval as money itself. How can there be money without gold? Well actually there hasn't been much of a connection since 1971, when Richard Nixon formally abandoned the gold standard - under which the dollar was exchangeable for a fixed amount of gold - and devalued the dollar.
The great inflation that this action helped bring on led in later years the likes of Lord Rees-Mogg, former editor of the Times, to advocate a rediscovery of the principles of sound money, supported by a return to the gold standard. However, even he would these days admit that the fixed exchange rate system it gave rise to is inappropriate to the modern world and bound to be blow apart. We have since discovered that inflation is a complex and many headed thing, and it unlikely to be cured by the use of fixed exchange rates alone.
In any case, the problem we are faced with today is the reverse of that of the 1970s. Rather, it is one of low inflation, running in some parts of the world such as Japan to outright deflation. The upshot is that there is no point in countries holding gold as a reserve any longer.
Gold producers have been desperately trying to persuade central bankers and governments otherwise. Stung by complaints that it is impossible to earn an income out of gold, producers have devised ingenious schemes for extracting yield, chiefly by lending gold reserves to the market. All of them tend to be complex and hardly worth the candle.
The awful truth is that over the last twenty years, gold has been a shockingly poor investment for governments. The cost of storing and protecting it has also reached alarming proportions set against the minimal costs of financial assets.
These sales are bound to be criticised by some as a dangerous departure with tradition and history. How silly and short sighted of the Treasury to sell out at the bottom and reinvest the proceeds in US, Japanese and Euro bonds just as these investments are beginning to top out. Typical. Many will also continue to see gold as more than just another commodity. Its beauty, history and power to adorn should ensure it remains much more than that.
But there is none the less an inevitability about what is happening. Gold's position in the international monetary system has been on the wane for many years now. Today it is almost an irrelevance. It has even lost its traditional function as a reliable store of value. Pathetic though the returns have been, even a building society account would have done better than gold over the past two decades.
There will always be those who want gold. In many parts of the world its position and value is enshrined in cultural tradition. And while we in the West with our stable currencies, lenders of last resort and deposit protection schemes, regard gold as a spent force, it is easy to forget that in many emerging markets it has continued to play a valuable role as a hedge against financial turmoil. Even so, in the absence of world war three, it can be said with some certainty that the gold bug has finally been laid to rest - probably.
Dow madness
When it comes to stock market investment, there is rarely any such thing as an independent view. Thus we had two very different perspectives on soaraway US stock markets this week. Katherine Garrett-Cox, head of American equities at Hill Samuel Asset Management, is still a raging bull, but then she would be. Her funds are reported as being the best performing in the UK over the last twelve months. If Wall Street goes pear shaped, she'll be among the worst performing in the next.
Meanwhile, Bill Martin, head of research at Phillips & Drew, says in a research paper that Wall Street is more than 60 per cent overvalued, and by implication, heading for a nasty fall. Again, he would do, for that has been pretty much the house view these past three years. P & D has to justify its failure to thunder with the herd somehow or other.
Of the two, however, it is the Bill Martin analysis which is the more compelling. The overvaluation figure is arrived at using fundamental stock market analysis techniques, the detail of which need not bother us here. But essentially it comes down to the common sense observation that the market has overperformed its long term trend for some considerable length of time now. Past points of abnormal overvaluation have nearly always been followed by periods of sub normal stock market returns.
What Mr Martin refers to, perhaps predictably, as "today's bubble", is the biggest such valuation anomaly identified by these methods in the post-war era.
Investors are on the whole a sophisticated lot, and they are just as capable of seeing these things as Mr Martin. So why do they continue to ignore the warnings? P & D suggests complacency brought on by two things. First is belief in the new economy - the idea that America has entered a new and sustainable era of steady, inflation free expansion. In other words, investors believe that this time round it really is different.
Second is the belief that the Federal Reserve will underwrite the stock market through interest rate policy.
Alan Greenspan rode to the rescue when things looked rocky last Autumn, so presumably he'll do it again. Mr Martin believes that neither of the these things would survive the prolonged period of economic weakness that would follow a reversion to more normal private savings behaviour.
This may be true enough, but actually one of the reasons why Americans aren't saving is because the stock market keeps rising, which makes them feel wealthier and obviates the need for saving. A return to more normal saving habits probably requires the stock market to fall first.
Nor does Mr Martin address the obvious point that so long as Americans continue to believe in the new economy and the safety net of the Fed, the stock market will continue to gain support, however misguided they might be. The more interesting question, then, is what might puncture these beliefs. There's nothing obvious on the horizon, but as this column has said before, a resurgence of inflationary pressures leading to a rise in interest rates continues to be the most likely cause.
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