Bullion: Barbarous Relic, Bubble or Boom

The topic of precious metals is a contentious one; provoking extreme and often entrenched reactions. The Depression-era economist John Maynard Keynes once described gold as a ‘barbarous relic’. This was in part due to its ancient role as a currency but also because its restraining effect on money supply when the economy was on its knees. With good stewardship there should be no place for using metals as money but the human desire to live beyond our means has been our undoing. Paper money has been the passport to profligacy and we are just beginning to pay the price for trusting in promissory notes with no foundation.

Financial folly and war have made easy bedfellows down the ages. By regarding the recent actions of gold in an historical context one realises how little has changed. The rise and fall of the Roman Empire acts as a worked example given its many parallels with the modern world. Vested interests and lobby groups influence modern Senators as much, if not more, than their Roman counterparts. In the First Century AD, the coins of the realm reflected the might of Rome through the high purity of their gold and silver content. By 275 the Empire was on the verge of collapse as the appalling quality of the coins led to a price spiral and hyperinflation. The Mint workers were stealing precious metals and replacing them with base metals, hence the term debasement, which we still use in modernity. Emperor Aurelian was forced to return from fighting on the frontier to deliver justice to the Mint workers on the home front. Having dispensed with them in a pitched battle he then recalled all coins and re-issued them with a small proportion of silver, leading to financial stability and a new-found faith in the currency.

Similar ferocity was meted out in the Middle Ages to those whose theft of metals destabilised the economy. Henry I summoned all Mint workers to Winchester where those found guilty of producing sub-standard coins had their right hand cut off and were castrated. There is a rationale behind this medieval mutilation. Those who inflate prices by devaluing currency are stealing from the future generations and therefore do not deserve to procreate. A similar theme of theft is apparent today. The next generation is forced to take out massive mortgages to pay for bloated house prices; inflated by endless money creation since the end of Gold Exchange Standard in the 1970s. Surely there can be no other species that squanders resources at the expense of their offspring.

While the Gold Standard is often cited as the best way to restore discipline we should remember that it failed several times due to lack of stewardship and war-related spending. This is not the fault of gold but of human nature. Indeed, the much-loved Wizard of Oz written in 1901 was a parody of the Gold Standard (yellow brick road), which called for silver to be included in order to boost the amount of money in circulation. The immobile Tin Man and scraggy Scarecrow were indicative of industry and farming, while the Wicked Witch of the North represented the evil bankers and speculators in New York. In the original book, Dorothy’s slippers were silver but ruby was colour of choice for the Hollywood pioneers of Technicolor.
Moving into modernity George Soros was mis-quoted at the Davos World Economic Forum, describing gold as the ultimate bubble, which prompted a sell-off. It soon transpired that his full quote was ‘gold will be the ultimate bubble’. Small words make a big difference and were backed by actions in doubling his bullion exposure in the final Quarter of 2009. Soros co-founded his flagship Quantum Fund with Jim Rogers (author of Hot Commodities) who knows a thing or two about periodicity. By analysing the behaviour of commodity cycles over the last two centuries he found that they lasted 17 years on average. Even if we had not witnessed the astonishing volume of money printing since 2008 it would imply that we are due at least another 7 years of a commodity bull market. It is interesting to note that during such episodes equity markets tend to fall or stagnate and the last decade has been no exception.

The question remains as to whether gold is in a boom or bubble so financial and psychological indicators should be consulted to see where we stand. Bull markets start with cynicism, mature into acceptance and eventually mutate from exponential to parabolic growth with prices veering vertically up the charts. Gold appears to be entering a boom phase and bears more than a passing resemblance to the NASDAQ 100 from 1990-95. Technology stocks then went into over-drive from 1995 – 2000 which is where gold looks to be heading. If the precious metals follow this bubble trajectory then the likes of gold at $6,000/oz shifts from the realms of fantasy to feasibility. History tells us that suppressing interest rates below inflation acts as a pressure cooker for bullion prices, which appreciate by 28% per annum in these conditions. Applying the same growth to gold in the coming years would have an enormous compound effect on the price. The gold guru and author James Turk believes that the ratio of the Dow Jones index to the gold price will revert to a 1:1 ratio which has twice been reached at the extreme of the inverse financial/commodity cycle. This would herald the Dow Jones index at 8,000 with the gold price at $8,000. Market forecasters ahead of their time are either viewed as madmen or Messiah’s whose views generate discomfort or admiration in turn.

The investment community has grown up with paper assets and leverage and little understands the beauty of tangible assets free from liabilities. Gold is not widely held in portfolios and public ownership is negligible. If anything, rising prices are tempting people to sell their jewellery to the plethora of companies offering abysmal prices for cash-hungry clients. The peak of a bubble is characterised by widespread public ownership, massive media coverage and the abuse of borrowing to gain maximum exposure to the asset (think of the property market in 2007). Gold ticks none of these boxes and we seem to be many years away from a precious metal mania. In conclusion we appear to be at the mid-point of a gold bull market. This could enter bubble trajectory if central banks and governments continue to act for self-seeking vested interest groups who will ultimately destroy paper money and impoverish the public in the process. Lord Rees-Mogg summed it up succinctly ‘Governments lie, bankers lie, sometimes even auditors lie; gold tells the truth’.

Toby Birch,
Guernsey Gold Limited