Gold gains as investors lose faith in US dollar

Gold prices in Mumbai closed at an all-time high of Rs17,455 per 10 grams on Saturday, giving a return of 42%, or 49% in US dollar terms, over the last one year.

In what has been termed the trade of the decade, gold has given an absolute return of a whopping 300% in dollar terms since the beginning of 2000. Its price increased from $281.5 per ounce (one troy ounce = 31.1 grams) on January 4, 2000, to around $1,151 per ounce currently.

The irony, though, is the metal which economist John Maynard Keynes once called a “barbaric relic” has limited use other than ornamental value. “You can’t eat it, it has limited industrial use. It is a strange belief in its power —based on scarcity, inability to control availability and an enduring history,” says Satyajit Das, an internationally renowned risk consultant and author of the best-selling Traders, Guns and Money. “Gold always does well in periods of political and economic uncertainty. It is a bellwether of economic temperature.”

Investors are losing faith in the value of paper currencies, say experts, and that is driving up the price of gold. Till the turn of the century, the US dollar was deemed the safest asset on the planet. But with the US going on a borrowing binge and the total liabilities of its government being estimated at $60 trillion, the currency is looking ragged. Other western economies aren’t in great shape either.

“Many nations in the West are already bankrupt (the US, the UK, Spain, Iceland and Ireland). For example, America’s total debt is over $60 trillion (and rising) and there is no way the US can ever hope of repaying it in today’s money,” says Puru Saxena, CEO of Hong Kong-based Puru Saxena Wealth Management.

The way out for countries with massive debts is “to print money to repay”, says George Cooper, author of The Origin of Financial Crises: Central banks, credit bubbles and the efficient market fallacy. “As that process continues, the value of paper money will deteriorate, a reason why people are holding gold.”

“Nobody wants to hold the US$ because of the fiscal and monetary policies of the US administration and structural problems. But nobody wants to hold the Euro or the yen either. So they hold gold as a bet against currencies. It is the default choice,” explains Das.

As more people hold gold, its price surges, say experts. “Gold has been rising all decade but its rate of appreciation is about to accelerate as people flee paper currencies and choose to hold gold instead,” says James Turk, a gold bull and the co-author of The Coming Collapse of the US dollar.

Gold prices, says Saxena, “could touch $1,300-$1,400 per ounce by spring next year. If the crowd becomes euphoric, we could go higher by April-May.” Turk agrees. “I expect gold to reach $1,200 to $1,400 by the year-end. By the end of 2010, it will be over $2,000, and perhaps well into four digits,” he says.

The other major factor propelling gold prices could be the rise in Chinese consumption of gold. Reports suggest that the Chinese government has been encouraging its citizens to buy gold. As Jeff Nielson, editor of www.bullionbullscanada.com says, “China is stepping up as a new major consumer at the individual and government levels. I would expect the same steady ascent we’ve seen since August — and a price of around $1,600 per ounce by 2010-end.”

With prices shooting up, is there a bubble in the offing? “I don’t think there is a bubble yet. But it will become a bubble — that’s how things work out,” says Cooper.

Other view: too much concentration on gold
Gold may be gleaming by and large, but not everyone is convinced. “Gold bugs excitedly speculated about gold prices reaching $2,300 per ounce. But, even at that price gold would merely match its January 1980 peak after adjusting for inflation; in other words, you had earned nothing on your investment over almost 30 years!” says Das.

What could go against Indian investors is the continuous appreciation of the rupee against the dollar. “The entire benefit is not accruing to the Indian investor because of this,” says Vijay Bhambwani, CEO, BSPLindia.com, and author of A Traders Guide to Indian Commodity Markets. As the rupee increases in value against the US dollar, Indian investors get fewer rupees for every dollar increase in the price of gold. This can be seen in the performance of gold over the last one year.

Experts feel there is too much concentration on gold. The reasons why the yellow metal is increasing in value should, logically, apply to other commodities, they say. “Gold is what everyone focuses on. We should apply the same logic to all commodities. Oil, land, silver — you can’t print any more of them,” says Cooper.

“I have always liked oil/energy and food — there are physical limits on production, neither has substitutes and we can’t do without them,” adds Das. They are also bullish on the agricultural commodities space. “Of late, there are emerging opportunities in the agricultural commodities space that can outpace the returns given by gold over the last two years. I am referring to buying foodgrains, pulses and edible oils,” says Bhambwani.