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Gold nuggets

Is gold the next asset bubble?

By Graham Bentley | 08:23:01 | 29 October 2009

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The price spike in gold has all the hallmarks of a bubble, says Graham Bentley of Skandia UK

Gold is pretty – and pretty useless. It makes a half-decent conductor of electricity (but silver is better and cheaper) and makes millions of brides happy. And it is a received wisdom that in times of uncertainty investors turn to gold as a hedge against disaster.

Given that gold is one of the few investments that is not simultaneously an asset and someone else’s liability, that insight has some rationality to it. The dollar spot price of gold has behaved according to the script since October 2007, rising by around 40% while the FTSE All Share Index fell 16% on a total return basis; sterling investors would have doubled that profit.

A fool’s myth busted

Today gold is the new alternative investment. Retail investment magazines opine on its attractions and purported usefulness as an inflation hedge. I am sure there is a story about gold that makes sense but let me lay this inflation-busting myth to rest. In the 86 10-year periods since 1914, the average real return on gold in sterling terms is minus 9.7%. Investors would have lost money in real terms in almost 70% of those periods.

What is more, the current sterling gold price is fast approaching the all-time inflation-adjusted high it hit in 1980. That event marked the end of a chaotic 15-year period known as the Great Inflation and presaged what we now call The Great Moderation, in which interest rates and inflation plummeted through the next 20 years.

It was during the coincident oil-price crisis in the 1970s that gold gained its reputation for being an inflation hedge but that period is untypical. From the peak in 1980 the inflation rate declined, but cumulative inflation climbed inexorably. Rather than keeping up with inflation, the price of gold fell from the peak of $850 per ounce to less than $275 in 2001.

And in inflation-adjusted US dollars the scene is worse. The January 1980 price in 2009 inflation-adjusted dollars was almost $1,700 and it fell to less than $327, losing more than 80% of its value. So even though inflation continued, the gold price fell.

Gold is not an inflation hedge

What does this tell us? Gold is not an inflation hedge. It is a crisis hedge, and crises do not necessarily involve inflation. Look at 1931 on the graph when the UK came off the gold standard, and 1971 when the US did the same. Despite last year’s market mischief, we are not in the same league as the 1970s’ hyper-inflation and global recession. On the contrary, evidence that the current recession is over is visible across the globe (if less so in the UK).

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Comments (12)

James - Gold price shall rise up to $1200 by end of 2009

10:52 | 29 Oct 2009

Some expert say Gold price shall rise up to $1200 or higher at the end of year 2009? Is it true?

David Robertson - Gold price rise to $1200

11:56 | 29 Oct 2009

Isn't this a case of traders talking up the price again? Wasn't oil supposed to hit $200 dollars a barrel earlier this year?

REVEREND_BRUSH - gold price to rise further

12:21 | 29 Oct 2009

Is it not commonplace that a lot of market "reaction" is spurred on by the comments of the experts?

these are the very people that make a very good living on the back of the fact that it costs to trade.

market ups and downs are obviously driven by company performance but how much of an influence do "the experts" opionions have on what people will buy or sell?

they are creating their own wealth by preying on the uncertainty of the average person who will listen to them.

Chris B (Slough UK) - Quantitative Easing

12:30 | 29 Oct 2009

There is no doubt that the Governments are pumping in Billions and Trillions of easy print notes. That is the whole point isn't it?

As you print more money, your currency devalues, some time later on. Gold of course doesn't strictly speaking rise in price, it is the comparative currency devaluing that gives the apparent price rise. Yes there is speculation and a bubble, probably a big one will no doubt occur. I do not believe we are there yet though. It is most likely that the markets will fall and probably fall hard. This will strengthen the Dollar in the short to intermediate term, but long term there is no escaping all those fresh notes injected into the system. Also much of the Dollars strength in particular, comes from those holding Trillions like China, Taiwan and Saudi, etc etc. If these countries start dumping the Dollar, it would fall real hard. If you don't think there would be a rush for Gold under these circumstances, then you must be on another planet! The risk of Hyperinflation is very real and should not be understated. You cannot borrow yourself out of debt....at least not for too long! There has to be pay-back. That is what the Quantative Easing is doing just pushing the problems forwards into the future, but in reaity creating a bigger problem down the line. Meanwhile the banks can make as bigger mess as they like and knowing they are going to get bailed out if the sh*t hits the fan. Never mind the currency or effect it has on the people, so long as the banks are taken care of right. $2000-$3000 Dollars in 3 years time does not seem unreasonable to me. Thats not to say there won't be big falls and large volatility in the process.

gazkaz - What idiot wants gold !!

13:57 | 29 Oct 2009

The value of Sterling is backed by a basket of currencies & GOLD.

All the currency in that reserves basket are also then backed by a basket of other currencies & GOLD.

When China starts dumping dollars to INCREASE IT's GOLD RESERVES - I always have a reality check..

Seems overall to suggest GOLD must have some sort of attraction perhaps.

Otherwise why isn't a curreny backed by reserves IN EQUITIES.

I think I might follow the obvious idiots such as the US Fed and hold some of the useless stuff.

DR - Finally

14:26 | 29 Oct 2009

Gold is just the latest bandwagon on which fearful investors are still considering. It is not bad to have a bit in the portfolio in some form or other. But what use is gold apart from jewellery? You cannot trade it as a pure currency, so it is useless from the point of view of acquiring worldly goods. If there is an efficient currency then you shouldn't depend on it to make you rich.

While that bandwagon trundles along the people on it will see a couple of shrewd people on the other platform quietly board a fast train - destination 'the next big thing'. The train will be going too fast again by the time they all try to switch over.

Nick - Sovereigns v. £s

19:04 | 29 Oct 2009

In 1914 you could have exchanged a gold sovereign for a pound note.

On the basis that a sovereign was approx 1oz then if you had kept it it would now be worth £630.

If you had invested the £1 note at 4% compounded it would now be worth approx £30 -- that is why gold is and always will be a worthwhile investment.

White Rabbit - Tangible Assets

20:07 | 29 Oct 2009

I think Mr Bentley suffers from tunnel vision.

He seems to have based his argument on very limited parameters.

If you consider the practicality of a small investor holding or trading the ACTUAL METAL over the short time frames he mentions of course the figures do not stack up.

But the fact remains that wealthy people, cash rich companies, and Countries with budget surpluses, buy gold, lots of it.

Right now there are Countries which are building substantial budget surpluses who want to diversify their reserves into easily tradeable alternative assets.

There are private investment companies who fear their capital will be eroded by inflation, and their are many millions of Chinese, Indians, and Brazilians who have previously only dreamed of owning gold jewelry who now find they have the cash to indulge in the luxury.

On the supply side the increase in value means that fresh opportunities are opening up for the miners. Previously unviable prospects now seem feasable. Also new technology can be applied.

e.g. huge spoil heaps standing at existing mines (considered useless waste until recently ) can be recycled to leach out highly profitable quantities of minerals.

Therefore there are numerous oportunities for the small investor.

I am particularly attracted to miners listed on the AIM market because there is the chance of scoring a triple whammy. i.e. The metal price may go up, currency exchange may turn in my favour, and the company could beat market expectations.

William Hammond - Gold is Money

23:17 | 29 Oct 2009

Gold is money and has broadly retained it's value for over 6000 years.

We are entering strange and unpredictable times and the jobless recovery in the stock market is evidence of insanity.

It won't last but gold will

Dennis - another bubble

23:33 | 29 Oct 2009

Remember the experts saying that oil would be £200 a barrell?

In every financial crisis or bubble the claim is that this time it's different

Oh yes?

Mark Herpel - Wow, are you wrong.

02:41 | 30 Oct 2009

Wow, I finally found the only web site on the Internet with a negative attitude towards gold.

I'll be back again in 10-12 months we can talk again.

Oh and whoever this is: The value of Sterling is backed by a basket of currencies & GOLD.

No...your glorious UK leader sold the gold some years back. Pounds sterling is pure paper. Good luck with that.

Mark

editor@dgcmagazine.com

Nickelless - Last time I checked, the value of gold never goes to $0

10:24 | 01 Nov 2009

This article is one of the dumbest things I've ever read. Gold has been considered a monetary metal for thousands of years and ALWAYS has intrinsic value, which is more than can be said for worthless fiat paper. Ever hear the phrase "not worth a continental"?

Since this guy is so down on gold, maybe he needs to do a little research on present-day Zimbabwe (which earlier this year issued a $100 trillion bill--of which I bought one on eBay for $9) or Weimar Germany. I'll take gold any day over your worthless bank notes, sir.

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