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In the sepia-tinged past when there were but three terrestrial TV channels in the UK and no household owned more than one receiver, Christmas viewing was both familial and communal. Before the advent of VCRs, big films were an event. One eagerly anticipated annual treat was The Wizard of Oz. This timeless 1939 classic was as redolent of Christmas as midnight Mass, mince pies and mistletoe. These were more innocent times when the term “friend of Dorothy” referred only to Toto. Few viewers agog at the technicolor world of Oz would have been aware of the political subtext of the story. The original book by L Frank Baum was published in 1900 and draws on the debates of the 1890s when the Democrats were opposed to the US staying on the gold standard because of persistent deflation. This particularly afflicted farmers, such as Dorothy’s parents, who were impoverished by falling prices.
Their champion was William Jennings Bryan. In a bravura performance at the Democratic National Convention in Chicago in 1896 he whipped his audience into a frenzy with this messianic declamation: “Having behind us the producing masses of this nation and the world, supported by the commercial interests, the labouring interests and the toilers everywhere, we will answer their demand for a gold standard by saying to them: ‘You shall not press down upon the brow of labour this crown of thorns, you shall not crucify mankind upon a cross of gold.’”
Cross of gold
The cross of gold has been borne with some success by investors of late. Since the then UK chancellor of the exchequer Gordon Brown single-handedly destroyed the reputation of Scots for canniness by announcing in May 1999 that he would sell part of the UK’s gold reserves, the price of the barbarous relic has risen by more than 450%. Over the same period the FTSE 100 index has fallen by 15%. Equities for the long run rings hollow.
The gold bugs also enjoyed a good 2009, with the price of the yellow metal increasing by 23%. However, those of you that followed this column’s suggestion last January and bought developed market equities would have outperformed. The MSCI World Index was up 30%. This is unlikely to shake the faith of gold’s disciples, who pushed the price of bullion into record territory at the end of last year.
Some of gold’s advocates try to make a fundamental case even at these levels. They point out, rightly, that adjusted for inflation, gold is only back to 1983 prices. It would need to rise more than 60% to get back to its inflation-adjusted peak in 1980. Jewellery still accounts for half of all gold demand, so the global economic recovery and a burgeoning middle class in India and China should help support the price. Chatter about “peak gold” from the chief executive of Barrick might be self-serving, but smacks of plausibility. A discovery on the scale of Yukon, which jolted the global economy out of its deflationary spiral in the 1890s, is not on the cards.
However, the two principal drivers of the gold price have little to do with fundamentals. Gold is a momentum trade. It has been on quite a run. When a bandwagon starts to roll, fellow travellers are soon on board. This is the sort of investing that creates booms and busts, but when markets turn these momentum traders rush to the exits.
The hard-core gold bulls are a different breed entirely. For them the yellow metal is a fetishistic obsession. The Taliban tendency gathers in corners to mutter darkly about fiat currencies. Their historical frame of reference consists largely of the Weimar Republic and modern-day Zimbabwe. They have palpitations about hyperinflation, ignoring the inconvenient truth that the world’s second-biggest economy has suffered from chronic deflation over the past two decades.
Broken multiplier
Inflation is always and everywhere a monetary phenomenon. In normal circumstances interest rates at zero coupled with quantitative easing would cause concern. But the financial crisis has broken the credit multiplier. The latest senior loan officer survey by the Fed revealed that banks continue to tighten the terms for credit. The same is true for much of the G10 as banks rebuild their balance sheets.
As consumers go through the painful process of deleveraging, shops are discounting more deeply than ever this sales season just to stay afloat. In an echo of the 1890s the process of globalization might have set in motion forces that lead to broad productivity increases and a diminution of pricing power.
A strengthening dollar, weakening oil price or softer commodity prices could all undermine gold. Those hoping for a spurt of inflation soon will likely suffer the same fate as the blind man in a dark room searching for a black cat that isn’t there. This column traditionally makes one trade recommendation in January. For 2010 it is to short gold. Goodbye yellow brick road.
Andrew Capon is editor-in-chief at State Street Global Markets, the research and trading business of State Street Corp. He was formerly senior editor at Institutional Investor and has won numerous awards for journalism on fund management and investment issues. The views expressed are the author’s own
