More to gold than glitter

The first chart here should be considered "scary," even though the trend line is "up". That's because it's a depiction of the rising price of gold – in euros. As you might imagine, the chart has been doing the rounds with increasing velocity over the past week or so. The chart simultaneously illustrates the flight to safety evident in growing investor demand for gold, and also the dire state of the euro, which has continued to fall irregardless of the euro zone governmental bailout package that was supposed to inspire such "shock and awe" in the financial markets.

So yes, the chart is scary. The "shock and awe", market-wise, lasted precisely one day before market participants began to wonder whether European Union governments have simply traded short-term liquidity risk for serious long-term political risk.

The European Central Bank (ECB) appears to have shot its own reputation to pieces. Here was a central bank that presented itself as being modelled on Germany's Bundesbank – an institution with proven inflation-fighting credentials – suddenly printing money to solve its problems. Having held out against quantitative easing all the way through the credit crisis, here was the ECB making a screeching policy U-turn in the face of a growing sovereign debt crisis.

But if the euro is in trouble, then so to are the other major world currencies. We have a situation that very much looks like competitive devaluation. And that's what has brought out the so-called gold-bugs – Apocalyptic observers offering dire predictions for the future of paper money itself. Fiat currencies are suddenly in the frame.

Note the writings of David Rosenberg, the former Merrill Lynch economist and strategist who now resides quietly at a Canadian brokerage called Gluskin Sheff. Here's what he told clients at the end of last week as the price of gold burst through $1,200 an ounce:

"What is happening today is truly fascinating. Gold has broken out to the upside even as the US dollar has done likewise on the back of a renewed flight-to-safety bid. What this means, of course, is that gold has managed to hit new highs even as, (i) the US dollar has risen, which means gold is breaking out against all major currencies; and, (ii) other industrial commodities, such as oil and copper, have slumped from their recent highs. So what this all means is that gold is no longer being considered as part of a resource complex that is outperforming the segment but is increasingly being viewed as a currency of its own."

Now, Rosenberg is no wingnut – even if he remained stubbornly bearish in the face of the equity market rally we have seen over the past year. He is talking here, in all seriousness, of gold being viewed as a currency in its own right.

The euro zone bailout has been widely compared with the post-Lehman collapse, after which gold declined sharply, from around $900 to a low of $720. But as Rosenberg explains,the post-Lehman period was actually like a giant margin call, where investors were forced to liquidate "winners" as asset prices everywhere went into spasm.

This time something else is happening. More from Rosenberg: "Moreover, with the growth rate of fiat currencies globally being met with a sceptical eye by investors, especially now that we know that if the ECB, of all central banks, can engage in debt monetisation [those clinging to the belief that this was modeled after the Bundesbank have been clearly duped], the one thing we do know about gold is that most of it is already above ground and that production peaked a decade ago. In other words, investors have more faith in what the shape and direction of the supply curve for bullion looks like relative to individual country money supply growth. This is why deflation is good for gold — the reflationary efforts provide a big boost. Even without the interventionist efforts to monetise the debts, as long as policy rates are near-zero, gold leasing rates will do likewise."

His point is that gold is a hedge against instability of all kinds and, while he thinks the gold price may be have run ahead of itself in the very short term, he believes gold is now definitely in a long-term secular bull market. If that is the case, then any short-term setback should be viewed as a buying opportunity.

Rosenberg scoffs at any suggestion that gold is "just another bubble". In fact, he makes the point that just a simple restocking of gold assets by central banks would send the price up to $3,000 or beyond.

The Gluskin Sheff man is by no means alone. The second chart here is from a hedge fund called Hinde Capital. It is not "scary" like the first one, but no less arresting. It shows the relentless rise of China's foreign exchange reserves – now close to $2,500 billion – and then maps the fall in China's holdings of gold expressed as a percentage of those reserves.

China holds very little gold indeed, but it has recently started to increase its purchases. And, as Hinde is telling potential investors, it makes a lot of sense to buy things that China is short of.

The same logic applies to central banks in other emerging economies – they hold very little gold, having chosen instead to place the bulk of their funds in the US treasury assets.

Until now, that is. India and Russia are already seen to be ramping up their purchases. Putting those fresh demand pressures together with the effects of investors fleeing hitherto "hard" paper currencies, it's hard to rests being gold bug too.

- The writer is associate editor of the Financial Times. The views expressed are his own


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