Gold: This Time Is Different?
Buying gold today is a bet on things staying all too much the same...
TWO-THOUSAND-and-NINE should have been the year gold took a breather.
The decade's best-performing asset class bar none, gold already matched the US stock-market's longest ever run of year-on-year gains (1982-1989), averaging 16% annual returns since 2001.
Yet the barbarous relic only rose further in 2009, hitting fresh all-time highs against all currencies except the Japanese Yen.
So will gold's oddly long-lived and still dismissed "bubble" finally pop in 2010?
Economists forced by its performance to consider gold are quick to note that it pays you no income. Modern metrics thus cast gold as invaluable, too often confused for worthlessness. Nouriel Roubini claims gold has "no intrinsic value"; in the absence of rapid inflation, he says, this must be a bubble.
Little-used by industry however (just 14% of average annual demand over the last 5 years), gold's economic value comes rather in its social use - a store of wealth when everything else fails. And outside precious metals and commodity trackers, the Noughties couldn't even live up to their name.
The worst decade for equities since the 1930s (if not the 1820s; depends who you ask), Y2K to 2009 also gave the developed world its first synchronized real estate slump. Yes, bond-buyers have now enjoyed a three-decade run, but to perpetuate that bull market in the Noughties, zero per cent interest rates - plus a flood of central-bank money creation in Japan, the US and Europe - were just the final insult for retirees and savers.
Cash deposits have long paid next-to-nothing after inflation, with tax-free UK cash ISA accounts returning precisely zip on average since early 2007. Six-month CDs in the US averaged 0.8% real returns per year during the last decade, twice what they paid during the 1970s but down from 2.4% in the '90s and 4.4% in the '80s.
For private capital seeking defense, let alone a return, such low-to-subzero real rates of interest negate the opportunity cost of holding gold - that rare, indestructible, simple and crucially non-defaulting lump of pre-modern money. Low real rates are also the common denominator between the last decade's four-fold gains in gold and the inflationary '70s. Which makes a surge in the returns-paid-to-cash gold's likely killer again in due course.
Whatever nominal hikes (or the mere threat) do to gold prices short-term, however, strong returns to bank savers remain a long way off, as Ben Bernanke announced in his "Blame regulation, not low rates" speech at the turn of this year. Professional Fed watchers are split as to whether the overnight rates will rise before 2011 or 2012, but consumers' natural reaction to the downturn - paying down debt and building new savings - is being overtly rebuked either way.
Working off the "Taylor Rule" that judges job losses against a loss of purchasing power, an internal Fed paper in spring 2009 put the "ideal" real rate of interest at minus five per cent. Now facing six million US job losses since the start of 2008, economists led by Paul Krugman and Brad DeLong are calling for the Fed to set an explicit inflation target, so it can explicitly higher inflation. Absent a genuine "earnings surprise" for Japanese, European and North American equities meantime (driven perhaps by over-spent, over-taxed and under-employed consumers...?) stocks are already valued above their historic average in terms of price/earnings. Bear-market bottom this ain't.
Outside the developed (and increasingly decrepit) West...with its discrete pawnshops-by-post and half-emptied central bank vaults...the fastest-emerging economies are fast accumulating gold, both as private and public hoards. The Reserve Bank of India made headlines (and a 17% rise in gold prices) with its decision to buy 200 tonnes of gold from the IMF this November. The People's Bank of China quietly built its reserves all last decade, and Russia overtook the Netherlands in December as the world's sixth-largest hoarder. The real story going into 2010, however, remains China's private demand, with households buying more than four times as much gold as the PBoC in the last five years - a massive 1,775 tonnes - equal to more than 2% of China's famously huge personal savings from income.
What about valuation? All told in 2009, the world's total stock of mined gold rose in value to almost 11% of global GDP. It last peaked in 1980 equal to 18%, but that was when real interest rates were high, Western finance and labor markets were being deregulated, and East Asia's demand for gold - an end-in-itself, rather than an investment vehicle; the aim of accumulation, not the means - was suppressed.
Ten years into the current bull market, technical analysis might expect distribution from strong hands to weak. Yet while cash-strapped households sell their jewelry as scrap, hedge funds led by Paul Tudor Jones and John Paulson are only now building their positions. And the bull market in bonds, meantime - gold's nemesis last time around, with 10-year yields offered in early 1982 above 15% - has now run for 28 years. If any trend is hitting exhaustion, financing government spending at ever-lower rates of interest must be it.
Bond prices have already dropped back as yields have erased (and more) the quantitative easing plunge of March 2009. Now governments everywhere are preparing for an historic refinancing drive, costing the UK alone more than £215bn ($340bn) by the start of 2015 just to repay its maturing debts - well over 3% of GDP before any spending or "stimulus" starts. To keep a lid on bond yields with guaranteed buyers, fresh quantitative easing will no doubt arrive. But debt monetization would only bring forward the crisis, and a major sovereign downgrade, if not default, looks set to make headlines sooner or later.
How much further can governments abuse faith in their debts and currency? At a guess, we'll find out sometime before the end of 2019. But holding gold today - or even daring to buy gold's recent 12% drop - is a long way from saying this time is different. It is a bet instead on things all too much the same, starting with policy-makers caught between just the same "inflate or die" panic that kicked off when the Tech Stock bubble burst a decade ago.