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Abu Dhabi, UAEFriday 5 March 2021

Now is not the time to paper over financial cracks

Gold trading may be quiet now, but do not be surprised if that changes.

By the time August comes around I will have been working in markets for 27 years and the vast majority of that will have been spent in precious metals. One thing I have learnt in that time is that virtually everyone has an opinion on gold. Sometimes they are speaking with a great deal of knowledge but occasionally it is more of the shoot-from-the-lip variety. Or at least the soundbite is. Currently, there is much angst about the fate of fiat money with governments around the world printing paper. Most of the world's paper money is fiat money. Because fiat money is not linked to physical reserves, it risks becoming worthless due to hyperinflation. If people lose faith in a nation's paper currency, the money will no longer hold any value.

Clearly merely printing money is unsustainable in the long term but for a number of people this illustrates the problem with giving politicians control over the printing presses without a mechanism to limit their enthusiasm to create money. In other words, what is there to stop banknotes being worth less than the paper they are printed on? For some, it is simple. The world needs to revert to a gold standard - backing currencies by an asset that cannot simply be created. While there are various forms of gold standard - from the coins themselves as legal tender to bank notes redeemable in gold - they all have the same basis and that is to limit the amount of money in circulation. With concerns not only of the value of all paper debt - including that issued by countries - the attractiveness of an asset that is no one else's debt and can be used to keep governments in check appears compelling.

How easy would it be? Is it as simple as all the money in the world needing to be backed by gold? While I don't have a figure for global wealth, there are estimates that global investable funds are something like US$130 trillion (Dh477.49tn). On the basis of a current gold price of $1,100 that would tie up some 3.7 million tonnes of gold. The problem is that only about 165,000 tonnes have ever been mined.

The alternative would be that the gold price would have to rise to about $24,000 an ounce. And that assumes that all the gold in the world would be utilised. So governments would be forcing their citizens to turn over their wedding rings and raiding the museums. On the face of it, obviously nonsensical. However, there are concerns expressed, most notably in the US, about whether governments might make gold ownership illegal. As fanciful as that might sound there is a precedent: the US government did exactly that in 1933 under the former president Franklin D Roosevelt.

To add insult to injury the price paid for the gold confiscated was $20.67 per troy ounce and shortly thereafter the gold price, which was regulated, was raised to $35 per ounce. I cannot foresee an event such as this taking place again but concerns over history repeating itself does dictate how some people choose to hold their gold. While a price of gold in excess of $20,000 also may sound like the ravings of a madman, there are a number of intelligent people who cannot see any exit from the current predicament in which we find ourselves other than hyperinflation. In fact, I sat in a meeting last week with someone who told me that $20,000 was his forecast for gold, with other tangible assets also accelerating. He saw an oil price in excess of $750 a barrel.

I have heard other confident predictions, including the natural level for gold being the same, in dollar terms, as the Dow Jones Industrial Average - which would see gold's value increase about 10-fold. My own views are not so extreme although I would be tempted to argue that the recent trauma suffered by financial markets has been so extreme, and the loss of confidence in monetary authorities so profound, that it is not fanciful to imagine gold trading at all-time highs in real terms in the next couple of years. Extrapolated from the $850 an ounce it reached in February 1980 that gives a target of about $2,150.

That is for the future though. At the moment gold is trading very quietly and range-bound against the US dollar as markets wrestle with concerns over the fate of Greece and whether the IMF will be asked to step in, the impact of the President Barack Obama's healthcare reform in the US and whether Asian economic strength is enough to return the global economy to growth. In terms of euros though, gold continues to be only a couple of per cent below all-time highs and it is the performance of gold against other currencies that is key as investors look to the twin safe havens (at least for now) of the US dollar and gold.

Jonathan Spall is the director of commodities at Barclays Capital and is based in London

Published: March 31, 2010 04:00 AM


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