An independent professional's take on the latest news and trends in global financial markets

Gold still in the ascendant

Back from a break of two weeks to find that gold continues its inexorable ascent, briefly breaking the $1400 an ounce mark for the first time. It is interesting that the barbarous relic is finally becoming a subject of serious debate in mainstream institutional circles, as evidenced by the fierce debate that has greeted the President of the World Bank’s entirely sensible comment that gold should be among the indicators of inflationary expectations that are monitored by central banks.

On Saturday the Financial Times, the illustrious paper for which I write, carried a measured full page feature on the causes of the revival in interest in gold’s place in financial markets. This perhaps may have been prompted by the lively (and mostly critical) correspondence that its consistent anti-gold editorial stance over the years has engendered. To judge by the ferocity with which some mainstream economists have reacted to the President of the World Bank’s modest proposal, you would think that he had been advocating a full-blown return to the gold standard.

Jim Slater, who co-founded Agrifirma Brazil, the farmland venture in which I am also a founding shareholder,  has written a  lively defence of gold as an investment on his website. Here is an extract:

An important feature of gold is that it is not only what it is but what it is not.  Gold is not the depreciating US dollar and dangerous Greek debt and it is not cash in one of the many doubtful and depreciating currencies.  Gold is an alternative currency and is well suited for this purpose as it has seven key characteristics – divisibility, indestructibility, stability, homogeneity, cognizability, utility and portability.  (I remember these by the mnemonic DISH and CUP from the days when I was studying Economics!)

Gold is also in relatively short supply.  All of the gold ever mined would fit into two Olympic-sized swimming pools.  There are very few easy high-grade mines left to produce gold and it is staggering to think that a low-grade deposit might be viable with a grade as low as 0.6 grammes per tonne.  Bear in mind that a gramme is just over 1/28th of an ounce and that to bring a mine into production might require a capital cost of $500m.  This makes it clear why gold is such an expensive, rare and precious metal.

There are many critics of the idea of investing in gold but to my mind they are outweighed by the very high calibre of gold’s supporters including, for example, John Paulsen, who was one of the very few investors to forsee the credit cruch and made a multi-billion dollar profit out of it.  Also the Chinese, who know a thing or two, are encouraging their population to buy gold and India has added to its gold reserves during the last twelve months.

It may surprise you to know that I do not own any gold myself and I am not a constant gold bug.  However, I believe that gold is in a strong upward trend and now is its time.  To take advantage of this powerful market move I prefer to invest in junior mining stocks, which satisfy my demanding criteria.  They have been performing well, but, in my view, they still have a long way to go.  As Richard Russell of Dow Theory Letters is fond of saying ‘there is no fever like gold fever!’

A look at the gold price chart suggests that gold became somewhat overbought during its surge above $1400, so a temporary retreat form those levels is no surprise. Gold will always trade in a volatile range, one reason why academics and policymakers dislike it so much as a tool of monetary policy.  I see that Marc Faber, a longstanding supporter of gold, has suggested it could drop down to somewhere between $1000 and $1100 an ounce during its next correction. We shall see. As long as the Federal Reserve continues with its policy of quantitative easing, the dollar is likely to remain fundamentally weak, the world will face a period of negative real interest rates and the strategic case for owning gold will remain a powerful one, as a vote against the fallibility of fiat currencies in general. It is logical that gold should do well when real interest rates are negative.

Gold price chart – log scale

Written by Jonathan Davis

November 15, 2010 at 1:10 PM