Don't be fooled by gold - it's never shone as a hedge against inflation

Anthony Hilton
12.10.09

There can be few greater pleasures in life than lunching with gold miner Peter Hambro — doubly so when it is in the family restaurant Wiltons — and even or probably because one does usually come off second best in the argument about where the gold price is headed.

“What do you think of sterling?” he asked me last week. “Likely to fall,” I said.

“What about the dollar?” “Clearly overvalued” I replied.

“What about the euro? “Trouble is,” I said, trying to break the chain — “They are priced against each other and I think they are all over-valued.”

“Precisely,” he said. “That's exactly the case for buying gold.”

Well, the metal hit record highs three times last week, and the case for it is that all this government debt and economic stimulus will ultimately lead to inflation and/or the collapse in the value of the world's key currencies. As one who thinks the authorities will find withdrawing from quantitative easing to be much tougher than getting into it — something it has in common with a great many financial activities that seem like a good idea at the time — I certainly share the fears about inflation. What I can't really accept is that gold is the answer. It yields no income, it costs money to store and insure, and recent history suggests it does not deliver on its promise.

I am old enough easily to remember the great gold rush of 1980 when the metal soared to a then record high of $850 — for reasons that are not so different from those you hear today. After that great price spike, however, it fell back and languished at roughly half its peak level for the better part of 20 years. But the relevant thing to bear in mind for all those who think this metal is an inflation hedge is that $850 in 1980 money is the equivalent of $2300 today. Gold clearly has not kept pace with inflation. In fact, it is barely a third of the way there.

Indeed, the opportunity cost of holding the metal — the loss of interest forgone on a conventional bank deposit in a major currency — makes the loss from holding gold even more marked. A capital sum doubles in value over 25 years at an interest rate of 3%. So if that $850 back in 1980 had been put in a deposit account and left there to earn 3%, it would after 25 years be worth $1700 — and by now even more. Interestingly, one of the bullish forecasts currently doing the rounds from advisory boutique Edison predicts that gold will head toward $1900 over the next four years. Perhaps it will, but even if it does, it will still not have kept pace with inflation.

If the financial world is going to end and all law and order as we know it break down, gold as the universal store of value might be the thing to have. That was the reason some people bought it in the 1970s. But we're not there yet, and I can't believe we ever will be.

So other than being nice to have, the case for investing in gold looks to me like another example of the greater fool theory. It makes sense just as long as there is someone out there willing to pay even more for the metal than you did. But if there is no such greater fool, out there to whom you can sell, why would you buy it?

* It is impossible to take seriously the story that sports retailer JJB's rights issue has been derailed by an outrageous rumour alleging under the counter payments being made to Sir David Jones the JJB chairman, backed it would appear by some amateur forgers with a John Bull printing kit who tried to produce an incriminating bank statement.
Why does anyone listen to the stuff? The oldest adage in the stock market is that “where there is a tip there is a tap” - in other words never believe any rumours because they are spread by people who already have a position in the shares and are therefore telling you to help their bank balance rather than yours. In the current contact there is a short position in JJB which is not looking too clever. So a few stories are circulated to create a bit of uncertainty - that should be dismissed as no more than par for the course. Its called market abuse these days, but it is actually human nature.
What is astonishing is not that the sharp practice exists because it was ever thus - but how in our over regulated days people get in such a lather about it. Why can we no longer simply dismiss it with the contempt it deserves?

* If shareholders in the Royal Bank of Scotland think they have a legal case for damages against the directors of the company because the rights issue documentation last year failed to show how parlous was the financial health of the organisation, then what about Lloyds? That bank has been almost destroyed by the losses within HBOS, the bank it rushed to buy last autumn. Chief executive Eric Daniels subsequently told a select committee that his organisation had not had eoungh time to do as much due diligence as would have been desirable.

I don't believe any good comes of these actionsm but it wouldbe no surprise if someone somewhere has him in its sights for that.