There are no eternal truths about the value of gold

Tue, Apr 23, 2013, 06:00

Both inspired tribal loyalties, both tended to be feted by those who support sound money and fiscal conservatism, and both were buried this week. One literally, the other metaphorically. But the yellow metal is getting almost as many obituaries as the Iron Lady.

There have always been gold sceptics. Warren Buffett has stuck his oar in often enough, calling gold a "valueless asset" and its price gains "a self-inflating bubble." Ken Rogoff described it as "a very risky bet for most of us". David Buik of BGC told Radio 4 it was an asset "for vagabonds and spivs".

Recent converts to the anti-gold cause include big investment banks, most notably Goldman Sachs. Wealth managers have also joined in; the overwhelming gist of comments from my email inbox is either "we told you so" or "we got out of gold a few months ago".

So gold wasn't a safe haven or an inflation hedge after all. It was just another volatile, dividend-free commodity. Indeed, it was worse than that; you can wire up homes with copper, fashion aircraft from aluminium and power cars with oil. Aside from some minor applications in electronics, gold is good only for adornment. The decade-long bull market in a metal that's all but useless was just another speculative bubble.

For some, that's the end of the story. But others are already talking about whether it's time to buy, or at least, not time to sell. Hedge fund manager John Paulson says the slide has not altered his long-term view. Bill Gross, the bond fund manager, said he would still buy gold at its current price. At the end of March, gold was still by far the biggest single holding in Sebastian Lyon's very successful Trojan fund. Those who sell gold to retail investors, from BullionVault to the Perth Mint, have reported soaring demand.

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So let's run through the investment checklist. The fundamentals haven't changed much. Mine supply creeps up a little each year, and is augmented by recycling, especially when prices are high. Jewellery demand has been weaker lately while providers of exchange-traded products - big buyers a few years ago - are now selling.

Central banks, net sellers for years, are now buyers, but there have been suggestions that indebted governments should sell some of their holdings as part of their bail-outs.

In valuation terms, the argument is tricky. Gold doesn't produce an income so cannot really be compared to yielding assets such as bonds, shares or property. But you can compare its worth relative to other commodities. At current prices, an ounce of gold buys slightly fewer barrels of oil or ounces of silver than its 25-year average - so it's not screamingly cheap in relative terms.

But Paulson, Lyon and Gross, and many retail investors, probably don't buy gold because of fundamentals or valuation. For them, gold is a hedge against inflation, a safe haven in times of crisis and a portfolio diversifier. A 20 per cent price decline in the price of the metal, and more in the shares of those that mine it (see chart) doesn't change things. Are they right?

Gold is indeed a hedge against inflation. Researchers at London Business School studied real returns since 1900 and found that gold was the only major asset class whose value has not been reduced by rising inflation. But its volatility means it's not very reliable; there were lengthy periods of underperformance, including 1980-2001, when gold lost 75 per cent of its sterling value in real terms.

Is it really a safe haven? There isn't much correlation between the gold price and the Vix, the industry's "fear gauge. True, the Vix measures implied equity-market volatility, not the probability of fiat money collapsing under a tsunami of quantitative easing. Gold might outperform in such a scenario, or it might not (gold fell sharply when Lehman failed). Even if it did, governments might find a way to sequester it (as they have done before). As with most things relating to QE, we just don't know.

We do know that over longer periods gold prices are largely uncorrelated, positively or negatively, with those of other assets. So too are lots of other things - like the result of the 3.30 at Doncaster, or the chance of getting red on a roulette wheel - but at least gold's lack of correlation is investable.

Gold is also a reassuringly physical asset, not a counterparty promise. But so are houses, diamonds or paintings. It doesn't make them immune to falls in price.

jonathan.eley@ft.com

Copyright The Financial Times Limited 2013