Olive: Don't believe hype over gold

Investing zealots betting the precious metal will top $15,000 U.S. an ounce in the years to come will see their bubble burst – again

By David Olive Business Columnist

For the second time in 30 years, we're in the midst of a classic gold bubble.

There are "gold parties" akin to Tupperware parties across the U.S., where people trade in their gold jewellery and even gold dental fillings for cash.

"Goldbugs," the term for gold-investing zealots, are predicting a gold price of $2,000 (all figures U.S.) per ounce next year. And a rise to as high as $15,000 in years to come – a 15-fold increase over the modern-day record price of $1,086 set on Dec. 3, from which gold has since retreated 11 per cent.

U.S. talk-radio yakkers Glenn Beck and Watergate ex-convict Gordon Liddy have become paid shills for gold vendors. On behalf of an outfit called Rosland Capital, Liddy in TV spots describes gold as "an intrinsically valuable liquid preserver of purchasing power."

Bank of Nova Scotia, one of the world's largest precious metals dealers, has launched an online store for sales of Scotia Gold Bars and other gold items. Such is gold's demand among everyday folks, as the Star's Rita Trichur reported last week, that the U.S. Mint has suspended sales of its popular American Eagle one-ounce gold coin for lack of supply. The Royal Canadian Mint has some of its most popular gold coins on back order.

These are all classic "sell" signs.

And a few sages finally are beginning to say as much.

Jon Nadler, senior analyst at Kitco Metals Inc., says gold has been riding a "bubble" of "hot air." The Montreal gold expert, noting gold's historic role as a hedge against the world going to hell in a hand basket, warns: "Don't get carried away with scenarios of Mad Max," referring to the film set in an apocalyptic future.

Nouriel Roubini, economics professor at New York University and one of the few experts to warn about the epic U.S. housing bubble and its consequences when there was still time for central bankers to safely deflate it, this month warns about "the new bubble in the barbarous relic that is gold."

Reminding clients of his financial advisory service that gold "has no intrinsic value," Roubini finds no fundamental justification for gold's rise "with no near-term risk of inflation or depression."

Early this month, Hu Xiaolian, a vice-governor of the People's Bank of China, was asked if the central bank would be replacing more of its greenbacks with gold after a gold purchase earlier this year. He said that was unlikely given that the bank now worries about the emergence of a gold bubble.

To bet on gold, especially if one were to buy it at today's nosebleed prices, one must believe that the U.S. dollar will collapse in value and be replaced as the global reserve currency. You have to assume inflation will return to double digits as governments cope with admittedly massive debts they've taken on in combating the recession with their stimulus spending.

You have to believe some indebted nations, even the U.S., will default. And that, like the sovereign wealth fund (SWF) of Dubai a few weeks ago, all the world's SWFs will become insolvent, including those of Norway, Alaska and Alberta. You might believe, as some goldbugs do, that a medieval barter system is in our future.

We've been here before.

Gold hit its record, inflation-adjusted peak at $850 in January 1980. That too was a time of high anxiety, caused then by double-digit inflation and interest rates; huge public- and private-sector debt; and geopolitical uncertainty after the two "oil shocks" of the 1970s. In the short space of a decade, the price of oil – a much bigger part of the Western economy than it is today – had skyrocketed from about $2 per barrel to $34.

But then the U.S. Federal Reserve Board finally broke the back of inflation. Economic growth boomed in the 1980s, and the stock market entered its greatest bull market in history. And gold went into a 19-year free fall, plummeting to a nadir of $252.90 in June 1999.

Gold, truth to tell, is a lousy investment. It pays no dividends and incurs high storage costs. It is illiquid (try paying for groceries with a gold bar). And it's in almost infinite supply.

Central banks and the International Monetary Fund can and do regularly sell off gold from their reserves, flooding the market. Gold producers bring uneconomic mines back into production when a rise in gold prices makes them viable again.

And gold, unlike oil, does not change its chemical composition, and turn into something else, when used. Practically every bit of gold in use since the Pharaohs remains in existence. It is a notoriously "soft" metal useful in few industrial applications. For many precious-metals buyers, it is eclipsed in "aspirational" value by platinum.

And at its current "record" price, gold still hasn't recovered over the past 30 years to meet, much less surpass, the $850 that had Torontonians lining up around the block in the bitter cold of January 1980 to buy gold wafers, bars and coins at the since-defunct Deak & Co. at King and Yonge Streets.

Taking inflation into account, gold should now be trading at $2,163.62 to match its previous high. Anyone who bought gold at its historic peak in 1980 is suffering a $1,313.62 loss three decades later on every ounce of gold purchased at that time.

Gold has increased in price by about 350 per cent since its 1999 nadir. You would have done better in that time with shares in the prosaic Potash Corp. of Saskatchewan (up 771 per cent). If you'd bought stock in Wal-Mart Stores Inc. when it went public two years before gold hit its all-time 1980 peak, you would have gained 68,109 per cent on your investment.

Economic conditions today arguably are better than at the time of the mania three decades ago. The U.S. dollar has strengthened — accounting for gold's recent retreat - and will strengthen further as its economy recovers and its yawning trade gap with China narrows. It's the weakening of the greenback, more than anything, that accounts for the recent rush to gold.

Gold will retain its millennia-old appeal, freighted as it is with symbolism. But if an apocalypse truly does beckon, gold won't be much help to you.

As Roubini wrote his clients earlier this month: "If you truly fear a global economic meltdown, you should stock up on guns, canned food and other commodities you can actually use in your log cabin."

dolive@thestar.ca