The little yellow god

Dec 1st 2005
From The Economist print edition

Even at $500, it's still a barbarous relic

NOTHING swells the breast so much as the thought that you have been proved right at last. After riding high at the start of the 1980s, gold bugs had a miserable couple of decades. The price declined relentlessly, mocking their credo that the security of the financial system ultimately depends upon the yellow metal. Lately, though, the faithful have enjoyed their reward. In the past five years the price of gold has doubled. This week in Asian trading it briefly surpassed $500 a troy ounce—a level last breached in 1987. You can almost feel the bugs' excitement as the message sinks in: gold is back.

This being gold, the resurgence has brought forth all manner of alarming prophecies. The price is an omen of rampant inflation; bonds are doomed; the dollar is about to fall prey to the United States' reckless deficits; the euro will shortly be revealed as a worthless creation of bureaucrats.

The world is an unpredictable place. But, with the possible exception of a fall in the dollar, not much of the above catalogue of doom looks likely; and none of it has much to do with gold's good run. The dull truth is much less bullish for gold. Investors have put money into a wide range of metals, and precious metals' prices, including gold's, have risen with the base. Meanwhile, gold remains fundamentally unattractive. It yields nothing and central banks are sitting on vaultfuls of the stuff that they want eventually to sell. Gold bugs hope that $500 is the threshold at which mainstream investors will start once again to take an interest in the metal. Caveat emptor.

The fascination of gold lies in its being not only a commodity but also a store of value and means of exchange. The glamour and the mystique lie in the latter, monetary part. This is what draws gold bugs, but their story doesn't quite add up. The unbalanced world economy still faces risks. But the most recent rises in the gold price have come against a strong dollar, which is normally a sign of weaker gold and continues to confound warnings of a collapse in the greenback. Oil prices are plainly far higher than they were, but they have come off their peaks. Moreover, there have been few signs so far that oil prices are feeding through to a 1970s-style stagflation. Nothing in either bond or stockmarkets suggests that investors see much danger of such a thing happening.

Bear on bullion
Gold's renewed shine is best explained by thinking of the metal not as money but as a commodity dug out of the ground. In the past few years the price has climbed because mining companies stopped locking in prices by selling gold in advance—in effect, withdrawing a huge source of supply. Even then, gold has captured only 40% of the gains of other metals in The Economist's metals index, which has almost doubled since the start of 2003 thanks partly to fundamental demand from emerging markets and partly to investors in search of better returns than those from other assets. Gold would have done better had Chinese demand risen as fast as some expected; in fact, figures from GFMS, a consultancy, suggest it has been flat, even falling, over the past 20 years. Chinese investors now have other places to put their money.

Gold is still cheap compared with its peak of $850 in 1980. Today, adjusting for changes in American consumer prices, it is worth only a quarter as much. Gold bugs might see that as a chance to buy; others as a reminder of gold's enduring capacity to disappoint.