LONDON – Having trouble explaining to your financial advisor why you might want to make a gold investment today?
Try starting by noting that, whatever your advisor’s stance on gold today – long, short or indifferent – the recent run towards $2000 per ounce begs the question: How in the hell did this unyielding, relatively useless lump of metal get here?
Gold has more than doubled in price since the first interbank credit crunch, and it’s only attracted more headlines, and more investment dollars, as the crisis mutates. But gold had already trebled by mid-2007 from its 2001 low. And if that was a warning of trouble ahead, then investors and savers (not to mention their advisors) might ask what the 2011 rise signals to date.
The bull market’s birth, a decade ago, has been variously attributed to gold’s “trinket price” base, the geopolitical fears sparked by Y2K and then 9/11, cycled investment flows as the Tech Bubble burst, and the acceleration of the United States’ twin deficits. In terms of both consumer goods and business assets, however, gold now stands well above its historic averages. Next year’s US presidential campaigns may see gold politicized as the hollow call for a Gold Standard grows. (Hollow how? Here’s how…) But for now, gold investment remains a monetary, not political phenomenon, as the daily spot price’s lacklustre response to both 2008’s South Ossetia stand-off and the 2011 Arab Spring show.
More fundamental was the 1999 announcement – spurred by the UK’s cack-handed disposals starting that summer – that European central banks would in future cap their joint gold sales. That gave the market fore-warning of what by then had become a huge source of supply (and a source that has since dried up entirely). It was in good part fed to the market through forward sales by gold mining producers, switching to a source of demand as the price of gold rose and miners scrambled to buy back their shorts, just about getting themselves even by 2010.
New mining output itself took until 2010 to breach its 2001 peak. That left so-called “scrap” flows – especially from previously unresponsive jewellery owners in North America and Europe – to meet rising demand, most notably from emerging Asia. Last year’s demand from India and China, the world’s two largest gold consumers, was twice the size of demand from Europe, the Middle East and North America combined, as economic growth released millions more families to start building discretionary savings. Indian households spent a record 2.6% of GDP on physical gold in 2010. As a proportion of China’s annual household savings, private gold investment (whether in coin, bar or jewelry) has more than doubled since 2001 to reach almost 2%. Anyone expecting a “gold mania” amongst US or European investors, therefore, may therefore be looking in the wrong hemisphere.
As recently as 2004, some Western gold-market analysts expected rising incomes in Asia to lead to substitution for consumer items and financial services. But it took the global downturn post-Lehmans, coupled with low demand outside the wedding and festival seasons, to make India briefly a net exporter of gold in early 2009 for the first time since the Great Depression. Gold retains deep religious and social significance across the sub-continent, and is similarly deemed an auspicious purchase by consumers in China. There, deregulation of the gold market, starting in 2002 with the launch of the Shanghai Gold Exchange, marks what looks a conscious effort by Beijing to diversify the nation’s savings. News of fresh hoarding by the PBoC is hotly anticipated, but new private demand has matched total official reserves in the last two years alone.
While the motives for Asian and Western gold investment might seem very different, however, one critical factor is common to both: low to negative real rates of interest. Sub-zero returns on cash are also the common denominator of the 21st century’s 600 per cent gains to date and the 1970s’ bull market. Because when cash loses value year after year, savers are forced to seek more reliable homes for their wealth. Rare, incorruptible and indestructible gold remains an obvious alternative, aided by 5,000 years’ use as a store of value. It has come to look increasingly attractive as debt instruments fail to pay. UK households, for instance, shaken first by the Northern Rock bank near-failure and then by quantitative easing, have now suffered bank deposit rates more negative after inflation than at any time since 1978. Western policy-makers are plainly constrained, in the face of rising inflation, by national debt levels. Central bankers in Asia are similarly hampered by the political imperative to maintain near double-digit growth.
Two global equity slumps, plus the US real-estate bust, have only helped the “case for gold” reach a widening market since 2001. So too has easier access to gold-price exposure, notably led by New York’s SPDR Gold Trust and other exchange-traded funds worldwide. ETFs have enabled US mutual funds in particular to track the metal, because they cannot own the physical asset by dint of their own charters. The Gold Trust’s brief spot as the world’s largest ETF by market cap this summer led many pundits to declare gold a bubble (a claim first made to me at the start of 2009, some $1000 ago). Technically today, gold’s recent price rise is nothing out-of-the-ordinary. Measured against its standard deviation of the last 40 years, the year-on-year change remains well below the “2-sigma” reading seen at the top of acknowledged bubbles in Japanese stocks, the Nasdaq, and most recently US housing.
Portfolio allocations to gold investment also remain low historically, most especially compared to the 20th century’s two economic depressions, when preservation of capital last overtook considerations of growth. The mid-1930s and early 1980s saw physical gold account for perhaps one-fifth and one-quarter respectively of all global financial wealth. Today, that figure stands nearer four per cent. US gold investment flows over the last decade account for less than 1% of household wealth at current prices.
So what are the risks, and how might things change? Between 1980 and 2000, gold lost more than four-fifths of its purchasing power, even though inflation twice topped double-digits. Ten-year US Treasury bonds, however, paid a real yield of four per cent per year on average, and UK savers enjoyed the strongest real rates since the classical Gold Standard. What killed gold’s last bull market looks a long way off yet. Nor can the miserable investment backdrop that’s nurtured and sustained it to date be discounted – not if your financial advisor understands how serious you are about defending your savings.
A version of this article first appeared this week in the Financial Times’ FT Adviser.
Formerly City correspondent for The Daily Reckoning in London and head of editorial at the UK’s leading financial advisory for private investors, Adrian Ash is head of research at BullionVault