FT – Friday August 26th
http://www.ft.com/intl/cms/s/0/ba41ac4c-ce78-11e0-b755-00144feabdc0.html#axzz1W88d5NNg
The biblical parable of the talents contains a timely warning for the gold market.
In the 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-goldbug to “outer darkness”
In today’s world a lot of wealth is effectively being buried. All the gold ever mined is still in existence. At the current price, it is worth over $ 8.5 trillion. This means the world is assigning roughly 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 has been ascribed to loss of faith in the banking system, loss of faith in paper currency, and loss of faith in the political leadership of the industrialized world.
Fear is certainly a key factor. When Ron Paul, the libertarian politician and veteran critic of the Federal Reserve, disclosed recently that his top ten stock holdings were all gold and silver mining stocks, the news reverbrated around the blogosphere. According to the Gold and Silver Blog,
“Ron Paul has taken steps to protect himself from the disastrous affects that Federal Reserve policies will ultimately have on the value of the U.S. currency. The average American would be well advised to follow his lead.”
Gold is thinly traded and supply constrained, so if the average American did indeed pile into the market, the price could go much higher. But is gold a safe asset regardless of price?
History suggests not. The last bull market in gold began in 1971 with Richard Nixon’s closing of the gold window and ended in a euphoric blow-out ten years later. Buying gold in its last parabolic surge proved to be a disastrous decision as the yellow metal then entered a twenty year bear market which saw its real price fall by 80%.
What about now?. It is ten 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 by 600%. This is much tamer than the 1500% 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 between 2004 and 2008.
Furthermore, the 1970s bull market in gold occurred at a time of raging inflation across the industrialized world and 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, however, government bonds are in a bull market that has taken their yields to multi-decade lows, and the CRB commodities index is stuck at 2006 levels.
The result of this strange dislocation is that in real terms this century’s bull market in gold already rivals the wild ride of the 1970s in scale.
So why gold now? Why not protect yourself through stocks instead? After all stock issued by a private sector company is a kind of currency and its supply cannot be increased without the say-so of the stockholders.
It might be objected 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 has risen 100% in real terms, whereas the real gold price is 700% higher.
Stock markets that have suffered serious corrections look better. Japan’s Topix Index has only once before been 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% 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 ensure that gold bulls, like the third servant, are reduced to “weeping and gnashing of teeth.”