Published in Financial Times August 7th 2012
Just like the non-barking dog in the Sherlock Holmes story, the gold price has become strangely insensitive to the usual stimuli.
The Eurozone remains locked in an existential crisis. Growth is fading in the US and China, and policy-makers appear conflicted or just plain clueless about how to respond. Meanwhile, losses and scandals at major banks are coming to light on a weekly basis.
Unsurprisingly, investors are running scared. The global flight to safety has seen capital flood into sovereign bond markets, driving yields down almost to vanishing point.
Yet despite this perfect storm of financial instability, the gold price remains becalmed. In fact, over the past year gold bullion has behavedmore like a “risk on” asset, rising and falling in synch with stock markets.
This makes sense. For most of human history, the yellow metal existed as an alternative to conventional finance, a “store of value” to be relied on in times of distress and crisis. Gold-bugs are loath to admit it, but those days are long gone. Gold has become just another tradable asset, as vulnerable to the shifts of investor sentiment as an emerging market. It is symbolic of today’s world that the largest ETF (Exchange Traded Fund) is invested in gold bullion, not equities.
So why has the yellow hound ceased to bark? One likely reason is that the price has simply become too rich.
All the gold that has ever been mined is still in existence, but it continues to exist because it is sterile – quite literally useless. As such it is hard to value, except by broad rules of thumb.
The current bull market saw the gold price rise from $280 per oz. to $ 1900 in 10 years. This is a rate of ascent comparable to some of the great historical bubbles such as Japanese stocks in the 1980s, NASDAQ in the 1990s and Chinese stocks more recently.
In inflation-adjusted terms, gold is extraordinarily overvalued. Not since the conquistadors discovered new sources of supply in South America has the real price sustained the level it is at today for any lenght of time. Only briefly in 1981 has the price been higher, and over the following 20 years it delivered a loss of 80% in real terms and a far greater opportunity cost as other financial assets soared.
Even now the total market value of all the gold in existence – which, remember, generates a return of precisely zero – exceeds the combined capitalization of the German, Chinese and Japanese stock markets, with all the productive capacity they represent.
According to the website pricedingold.com, gold is at a 120 year high (at least) relative to US house prices. Likewise, it is at a 74 year high relative to US wages, at multi-generation highs relative to wheat, coffee and cocoa and at the same price relative to the cost of a Yale education as in 1900.
Gold did not rise to these giddy heights by accident. A bull market of this scale requires widespread distrust of other financial assets, of the banking system, of capitalism itself. This was the case in the late 1970s, when Soviet expansionism and the bitter aftermath of the Vietnam war bred a growing pessimism about the future. When gold peaked in 1981, both equities and bonds were cheap by historical standards, having endured long grinding bear markets.
This time round bonds are expensive –if Sidney Homer’s History of Interest Rates is any guide, long-term interest rates are as low as they have been since Babylonian times. Meanwhile we are twelve years into a global bear market in equities, but the US equity market, the world’s largest, is not cheap on such long-term measures as the Shiller PER and neither are the most popular emerging markets.
So where is the safe haven that offers protection against the turbulence of financial markets? Guess what – there isn’t one. Everything has become somebody’s idea of an asset class, from dodgy modern art to the copper that burglars strip from church roofs. Everything carries some risk of loss.
Even so some assets offer more value than others. In Europe and Japan optimism has all but evaporated and Shiller PERs are low. For sure these economies face serious challenges, but that comes with the territory when assets are cheap. Even in a world of no capital gain, there is a case for solid blue chip equities purely on the basis of dividend yield, which is historically the main component of investment returns.
For those still nervous of financial markets, there exists an obvious alternative. On the pricedingold.com numbers, the best deal would be to cash out your gold, buy a nice house, hire some staff, send your kids to college and eat big breakfasts.