The Frightening Spike in the Price of Gold
The price of gold has been hanging near its historic highs, selling for more than $1,000 per ounce. In times of crisis -- the terrorist attacks of Sept. 11, 2001, the collapse of Bear Stearns in spring 2008 -- gold has spiked, as fearful investors grabbed for something they could hold onto.
But that's not the case today. The U.S. is technically out of its Great Recession, Fed Chairman Ben Bernanke recently said. New jobless claims unexpectedly fell last week. The stock markets are riding a 50 percent rally since March. And yet, gold keeps going up.
That means a growing number of investors, traders -- and, most troublingly, foreign governments -- don't believe in the strength of the U.S. dollar, analysts warn. People buy gold when there's fear.
"It's not the fear of an event of some sort," such as a terrorist attack, said Peter Boockvar, equity strategist at Miller Tabak, whom I spoke to this week. "It's the fear that the piece of paper in your pocket you call money will devalue over time."
To stave off a liquidity crisis last year, Bernanke's Fed turned on the money spigot, flooding the system -- and world -- with dollars. In the short term, that helped avert a second Great Depression. But in the long term, with each new dollar introduced into the system, each dollar you hold becomes worth less. That's more than just inflation, which we think of as simply rising prices. That's debasement of not only our currency, but the globe's reserve currency. And that makes countries like China -- which holds the greatest percentage of U.S. debt -- very nervous.
"It amazes me that any self-respecting central banker is not alarmed that gold is over $1,000 and the dollar is trading at all-time record lows," Boockvar said.
Let's back up here for a minute and consider gold itself. It's a complicated metal, and people buy it for a lot of reasons that have nothing to do with what it's worth.
Gold is a commodity, just like soy beans or wheat. But soy beans have no romance, no feeling of permanence, no surprising heft when you lift them. Spanish conquistadors did not pursue the New World's soy. There was never a James Bond villain called Wheatfinger. Gold is freighted with more meaning, really, than value.
People who want something to pass down to their grandchildren, for instance, buy gold coins.
People who want to diversify their investments buy gold.
People who fear inflation buy gold as a hedge.
But when foreign nations that hold billions of dollars in U.S. debt start buying gold because they fear the value of the dollar will go down, that's when the rising price of gold becomes more than a novelty.
The massive economies of China and India, as well as several emerging economies, are increasingly hoarding gold, said Michael Dudas, gold analyst at Jefferies Asset Management, whom I spoke to this week.
The argument shared by China and by other investors who have been loaning money to the U.S. during this crisis is simple, Dudas said: "They're looking at us and saying, 'If you keep printing too much money, what you owe me is not worth as much.' "
In periods of intense crisis, it's probably best not to use a gold price spike as a barometer, as people do not act rationally in a crisis. But in non-panic situations, such as the one we're in now, gold is a more useful barometer. And here are two readings from the barometer: The U.S. Mint has actually sold out of gold products in the past year. More importantly, non-commercial net long positions on gold are at an all-time high, the Commodities Futures Trading Commission said recently. Translation: Investors think the price of gold will continue to rise.
You can buy gold in a couple of different ways. You can buy jewelry or gold coins or actual gold bullion and store it in a physical location -- a safety deposit box, buried in your back yard, hidden under your bed. But that kind of gold is heavy and hard to move, which limits your use of it. For instance, there was $104 million worth of gold bars in vaults below the World Trade center, which could not be recovered until several weeks after the 9/11 terrorist attacks.
Physical gold is mostly for hoarders, and that's one kind of gold-lover: the person who fears the monetary system will break down one day, either from calamity or chaos, and paper money and wealth will become worthless. Some of the more extreme of these folk foresee a barter economy as an inevitability.
Most investors, however, buy gold through gold certificates, or in exchange-traded funds (ETFs), or buy options on gold, which let you trade the precious metal with the ease of stocks but theoretically with the security of gold. These investors tend to be less apocalyptic in their thinking but still like the idea of something that will hold its value simply because of its physical nature and scarcity, like diamonds or expensive art.
But there's a dichotomy at the heart of gold: Even though there is a finite amount of it that has been mined and is still buried in the earth, there is a massive oversupply of the metal.
Only 158,000 metric tons of gold have been mined in all of history, the World Gold Council estimates, 65 percent of which has been mined since 1950. Production is currently down and analysts expect it to remain flat for years to come, owing to the absence of major finds in recent years. (Consider the "rushes" of 1848 in California and 1886 in South Africa.)
About 3,000 metric tons of gold are produced each year, through mining and scrapping (melting old gold into new).
The world's central banks, such as the Federal Reserve, hold about 20 percent of the world's above-ground stock of gold, or about 30,000 metric tones. Here's where the massive oversupply kicks in: If the central banks decided to sell their gold, it would flood the market with a 10 to 1 supply to demand. And that would crater the price of gold. (The European central banks have been slowly selling their gold since the adoption of the euro.)
So that's something to keep in mind if you're thinking about becoming a gold investor: Unlike many other commodities, whose value depends on how much is farmed (soy beans) or drilled (oil), the value of gold is largely dependent on how much of what already exists is put into circulation. So there's an extra influence on supply and demand. (It's true that oil cartels "park" tankers full of oil to drive up the price per barrel. But nowhere near 20 percent of the world's supply. Further, there's a lot more oil in the world than gold, with massive new finds popping up frequently.)
Industrial production -- gold used in spacecraft and semiconductors, for instance -- accounts for only about 10 percent of all annual gold use. So if you're buying gold thinking a lot more of it is going to be used in the future to build things, that'd be reaching.
If, however, you want to buy gold because you're worried about the fate of the dollar, then you're in smart -- and worried -- company.
-- Frank Ahrens
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September 24, 2009; 12:27 PM ET
Categories: The Ticker | Tags: Fed, Federal Reserve, gold
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