Callum D’Ath: No end to the gold rush any time soon

Published on Sunday 12 February 2012 00:00

“NOTHING concentrates the mind of a man so wonderfully as the knowledge he’s to be hanged within a month.” Samuel Johnson’s wonderful quote brings to mind the recent procrastinations across the channel over the Eurozone crisis and rescue.

Metaphorically Germany is the man facing the prospect of being hanged within a month. The prospect of a market-induced break-up of the Eurozone would be economically dire for Germany, at least in the short-term, and the economic equivalent of a hanging.

This has concentrated Teutonic minds and progress is finally being made in at least discussing the only real outcome for a monetary union other than break-up – fiscal union, or for now at any rate, a “fiscal compact”. Of course, full fiscal union will not be easy to achieve, it will have to be sold to electorates which may require referendums in some countries due to treaty changes, it will not on its own solve the chronic lack of competitiveness of southern Europe but it should in theory give EMU a chance if properly enacted.

The implied quid pro quo for when Europe signs up to Germany’s fiscal union is that the European Central Bank may finally be allowed (by Germany) to embark on quantitative easing to buy Italy’s and Spain’s debt so that these countries can finance themselves at much lower interest rates.

If this were to happen, then Europe’s central bank would be joining global central banks in the great “race to debase” (their currencies). The Federal Reserve Bank in America, our very own Bank of England, the Bank of Japan, the People’s Bank of China and even the steady old Swiss National Bank have been printing large amounts of money.

Some countries like America and the UK may have done more relative to the size of their economy than others, but the scale of global money printing is unprecedented. If all these countries are printing money, how could the US dollar, for example, devalue versus the pound or the euro? Is it not a zero-sum game? Yes – in the short run it will not make much difference, however in the long run someone will win the race (by printing too much).

In the meantime selected equities, land and hard assets such as gold remain the best store of value.

Gold started a secular bull market in 2001 at approximately $260/oz (Gordon Brown infamously sold it at $275/oz in 2002) and it is $1,660/oz ten years on. Gold’s bull market is long in the tooth, of that there is no doubt.

Some class gold as a commodity, but I view it as a currency. It yields nothing, has no real industrial use outside of jewellery, is difficult to store and transport unless in gold coins but it is probably the only true global currency. Granted a gold bar will not buy you a coffee in Athens whereas a US dollar bill will still be accepted. But how much longer will people trust the greenback while the Federal Reserve Bank continues to print money? Gold is useless but it is its very uselessness which makes it so valuable in difficult times. When people become worried about the value of money – as they are now – they look to gold as a store of real value.

Were people not worried about the value of money then gold would lose its lustre. Were I more upbeat on the economic outlook for America, Britain and Europe I would surely be more bearish on the outlook for gold.

Unfortunately I suspect that economic growth in the West will remain pedestrian and “real” interest rates – the inflation rate less the interest rate – will be negative for a long time. That is not good for gold as it diminishes its relative value, as gold doesn’t yield anything or pay any interest and investors can opt for higher yielding alternatives when the real rate rises. Gold acts as a good hedge against inflation when the real rate is negative or low. While the real rate in America and Europe remains negative it is likely that gold will continue to appreciate in value in US dollars, pounds and euros.

So as long as economic growth in the West disappoints it is likely that central banks will print more money. This will continue to stoke fears of currency debasement which will increase demand for gold.

Many Western economies are struggling with high debts and slow economic growth, and are therefore keen to see their currencies weaken to aid competitiveness. These competitive currency devaluations mean that the currencies concerned are at risk of losing purchasing power. Central banks in the emerging world have therefore been diversifying their holdings away from just holding US dollars and euros and have been large buyers of gold.

The World Gold Council points out that emerging market central banks bought more gold in the first half of 2011 than they did in the whole of 2010. If, however, one were to turn more optimistic on the economic growth prospects for the Western World one would be a seller of gold and gold shares. That time will come but not in 2012, when one should continue singing loudly for “five gold rings” to slot alongside high-quality equities in a portfolio.

• Callum D’Ath is divisional director at Brewin Dolphin

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