The precious metal is a barometer of the current credibility of currencies.
Gold is unique in its ability to excite investors into extreme positions. And just as all of the world's gold has already been created, so too everything that there is to be said about the metal has probably already been said. But arguing about whether gold is overvalued or undervalued misses the point. The real value of gold lies in the information it provides to investors, and this is free of charge.
Some pros and cons
The principal pros and cons of gold can be summarised as follows. On the positive side, there is a finite amount of gold in the world. Nobody can make any more of it. Gold is valued in almost all present and past cultures. It does not degrade or waste away, and it is not consumed in the way that most commodities are consumed. It is also relatively valuable by weight or by volume, so large sums can be hidden or transported with comparative ease.
On the negative side, gold produces no income. In fact, holding it usually costs money in secure storage fees. Gold is also incapable of being used for most day-to-day purchases, as there are no small denominations. Try buying your daily newspaper with one thousandth of a Krugerrand.
Gold bugs
Gold supporters are often described by the pejorative term 'gold bugs', and it appears that (at least until recently) most respected investors had little time for gold. Keynes is often quoted as saying that gold is a "barbarous relic", although he was actually talking about the gold standard, a quite different subject.
Other critics, real or otherwise, are less restrained. But it is hard not to concede that gold bugs have a point: during the last century the US dollar has fallen by more than 98% in gold terms, and sterling by more than 99%. And those are the more successful currencies: gold has also survived countless other currencies which were wiped out by hyperinflation, war or regime change. Gold has its attractions for people who think in terms of generations. But what about the shorter term?
Recent price movements
On any measure the price of gold has risen dramatically during the past 20 years. Why? Price is a function of supply and demand, and since supply is (almost by definition) fairly stable one suspects that recent price rises have been caused primarily by an increase in demand. Why an increase in demand? The sudden arrival of hundreds of millions of Chinese buyers into the marketplace may provide a partial explanation, as well as momentum trading and speculative buying for short term capital gain. Low interest rates also play their part, since the opportunity cost of holding gold is primarily the interest foregone on your cash.
But none of these factors seems to tell the whole story, particularly when one considers that the recent increase in the price of gold has been much more marked when measured in some currencies than in others: since the start of the crisis in July 2007 gold is up 63% in Swiss Franc terms but 130% in US Dollar terms and 180% in Sterling.
Mother Nature's money
Gold is a form of 'money', that is to say a store of value and a medium of exchange, but unlike most other forms of money the supply of gold is regulated by nature rather than by man. So perhaps gold stands less as an asset in its own right and more as a reflection of man-made currencies, or more accurately as a reflection of the current credibility (or lack of it) of man-made currencies.
If everyone believed in stable currencies that yielded positive interest then the price of gold would crash. The more people distrust man-made currencies, the more they are forced by default to buy the only form of money that cannot be manipulated, still less printed at will.
The price of gold, then, is really a barometer of the current credibility of man-made currencies; particularly the most liquid, generally available and interest-yielding currencies which are, by definition, those which most gold buyers are rejecting.
Watch even if you don't buy
I don't own gold. It feels as if it is too close to the top of the market to make a sensible bet. And if we ever reach a stage where physical gold is the last remaining asset of value then capital preservation will probably be the last of my worries. But I watch the gold price carefully because of what it says about the credibility of currencies that matter, such as the US dollar, euro and sterling.
Ultimately these currencies are just pieces of paper – no longer backed by assets, they rely solely on the credibility of governments and central banks to maintain their value. Once that credibility starts to go -- once enough people start to worry about QE, inflation and deficits -- the consequences will be much more serious than rising jewellery prices.
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