The price spike in gold has all the hallmarks of a bubble, says Graham Bentley of Skandia UK
Gold is pretty – and pretty useless. It makes a half-decent conductor of electricity (but silver is better and cheaper) and makes millions of brides happy. And it is a received wisdom that in times of uncertainty investors turn to gold as a hedge against disaster.
Given that gold is one of the few investments that is not simultaneously an asset and someone else’s liability, that insight has some rationality to it. The dollar spot price of gold has behaved according to the script since October 2007, rising by around 40% while the FTSE All Share Index fell 16% on a total return basis; sterling investors would have doubled that profit.
A fool’s myth busted
Today gold is the new alternative investment. Retail investment magazines opine on its attractions and purported usefulness as an inflation hedge. I am sure there is a story about gold that makes sense but let me lay this inflation-busting myth to rest. In the 86 10-year periods since 1914, the average real return on gold in sterling terms is minus 9.7%. Investors would have lost money in real terms in almost 70% of those periods.
What is more, the current sterling gold price is fast approaching the all-time inflation-adjusted high it hit in 1980. That event marked the end of a chaotic 15-year period known as the Great Inflation and presaged what we now call The Great Moderation, in which interest rates and inflation plummeted through the next 20 years.
It was during the coincident oil-price crisis in the 1970s that gold gained its reputation for being an inflation hedge but that period is untypical. From the peak in 1980 the inflation rate declined, but cumulative inflation climbed inexorably. Rather than keeping up with inflation, the price of gold fell from the peak of $850 per ounce to less than $275 in 2001.
And in inflation-adjusted US dollars the scene is worse. The January 1980 price in 2009 inflation-adjusted dollars was almost $1,700 and it fell to less than $327, losing more than 80% of its value. So even though inflation continued, the gold price fell.
Gold is not an inflation hedge
What does this tell us? Gold is not an inflation hedge. It is a crisis hedge, and crises do not necessarily involve inflation. Look at 1931 on the graph when the UK came off the gold standard, and 1971 when the US did the same. Despite last year’s market mischief, we are not in the same league as the 1970s’ hyper-inflation and global recession. On the contrary, evidence that the current recession is over is visible across the globe (if less so in the UK).
