The gold boom

After a lacklustre period in the 1990s the price of gold has been rising, driven by the aftermath of 9/11, volatile equity markets and growing demand for jewellery from India
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The Independent Online

Gold at near 30-year highs? In a world of breathtaking financial ingenuity, the sun should have gone down on this most basic and ancient stores of value.

It's been around since at least 2560BC (that's Before Christ rather than Before Crunch in this case), but while salt, spices and sea shells have long been abandoned as forms of money, gold, hardly less risible if you take a step back from it, seems as resilient as ever.

Gold at $740 per ounce shouldn't be happening. By now gold ought to have been relegated to fillings and wedding rings.

It's almost a century since John Maynard Keynes dismissed it as a "barbaric relic", and only a few years ago the world's central banks, the Bank of England prominent among them, were offloading it as fast as they could, finally heeding the great economist's advice. Pushed down by those central bank sales, the gold price reached a low of $252.90 per ounce on 21 June 1999 – in real terms its most depressed market in almost three decades.

However, the gold bugs were not to be disappointed for long. Driven back up by the aftermath of 9/11, the "war on terror" and volatile equity markets since the collapse of the dotcom boom in 2000, the gold price has been rising strongly since 2001. It now stands at its highest since the oil crisis and Iranian revolution of 1979-80, when it briefly hit $850 per ounce.

Natalie Dempster, investment research manager at the World Gold Council (WGC), points to the metal's traditional "safe haven" characteristics as reasserting themselves in today's turbulent times. "Recently demand has been mainly related to the financial crisis, with people looking to 'real assets' rather than paper ones."

Investors also see it as an effective hedge against the weak US dollar, though it is retail investors rather than the large institutions who have been the engine behind the gold boom for most of this year. Only very rec-ently have bigger players started to follow their lead, with gold exchange traded funds (ETFs) enjoying a record inflow of funds in August. According to the WGC, "identifiable investment" in gold rose globally from $8,472m in 2005 to $12,483m in 2006, with ETFs accounting for about half of that increase (though ETF inflows dropped significantly for most of 2007). Not huge numbers, but with supply flat, it has had a dramatic impact on the price.

However, demand for gold in the jewellery market runs at more than three times demand for investment purposes, and here the Indian market is key to the story.

Even before the recent boom in the subcontinental economy, India has long been the world's major gold market by volume, easily outstripping Europe and the United States. Now the burgeoning Indian middle class has turned a steady demand into a rapacious one. The present spike in the gold price has a good deal to do with peak demand from India, as the wedding season (October to January) approaches. Jewellery was often the only asset a woman in wide swaths of Asia could own, and the annual saving for a girl's streedhan or wedding dowry is a sort of Indian version of the Child Trust Fund.

As it happens, Keynes' remark about the barbarity of gold related to his observations of its dominant place in India, something he regarded as "ruinous" to her economy. Now, at 317 tonnes, India's demand for gold in the second quarter of 2007 alone was equivalent to half the world's mining output. Overall demand (investment plus jewellery) for gold in India has almost doubled in a year.

Other nations with a sometimes violent economic history can also be observed to be piling into gold. Russia, home of all those fabulous Fabergé gold eggs, recently rediscovered its bourgeois tastes, and recorded its second highest demand for gold for jewellery, with consumption up 27 per cent.

Turkey, the Middle East more generally and China were the other principal growth markets, with Indonesia and Vietnam also getting the Midas touch.

Industrial demand and demand from central banks remains muted, however, with only the Russian and Qatari central banks putting much faith in the yellow metal.

As for the prospects for gold, at $750 per ounce in the three-month futures market, these seem healthy as well. According to the WGC, the "facts that have supported the market remain in place – as a hedge against dollar weakness, against inflation for long-term investors, and demand in key emerging markets with robust GDP growth. As low-income households move into the middle classes and with gold as a major discretionary purchase it differs from other alternative investments such as diamonds or silver as being a consumer good in its own right."

Gold bugs point to the inelastic supply of the metal as another factor underpinning its future. It takes seven to nine years to see a new gold mine fully operational, and there have been no new recent discoveries. Central bank sales are slowing down, partly because they have jettisoned so much of it already, while scrap supply is falling.

The cost of producing gold also puts upward pressure on values: this has risen from a mine-to-market rate of $339 per ounce in 2005 to $401 per ounce in 2006 as the price of resources used in mining gold have gone up almost as strongly as gold itself.

Reflecting on the difference between the asset and the industry, John Hill, director of metals research at Citigroup, said: "I think one theme that will be cast most starkly in contrast will be the difference between gold the asset, which looks better and better, and gold mining the business, which looks tougher and tougher all the time."

"Gold," Keynes wrote 1930, "has become part of the apparatus of conservatism, and is one of the matters which we cannot expect to see handled without prejudice."

Mercifully no one thinks it likely that any large economy will return to the Gold Standard, having its currency convertible into so much specie; a system that often crucified innocent economies. However, with financial conservatism rolling back into vogue and a growing prejudice in favour of this reliable financial ally, the barbaric relic looks set to survive for another few millenia.

Gold standard had its ups and downs in turbulent 20th century

By Emma Carroll

The first move to delink sterling from gold came in 1914, when the government suspended the gold standard for the duration of the First World War. Winston Churchill, as Chancellor, returned the UK to the gold standard in 1925, fixing the value of the pound at pre-First World War levels. The move was famously condemned by the economist John Maynard Keynes.

As a result of too high an exchange rate, the next five years were difficult for Britain and in 1931, following a run on UK banks' gold deposits that bought down Ramsay McDonald's Labour government, the gold standard was abandoned. Other countries soon followed suit.

In 1933, in the height of the Depression, US President Franklin D Roosevelt banned the purchase, selling, or owning of gold by US citizens. Gold prices soared more than 65 per cent fuelling a mining boom.

The Bretton Woods system, agreed in 1944, saw countries commit to maintaining the exchange rate of their currency within a fixed value in terms of gold. Until the early 1970s, the Bretton Woods system helped financial stability. But in 1971, amid government and trade deficits, US President Richard Nixon decided to deregulate gold.

The dollar and gold floated after 1971 and, in January 1980, the gold price hit a record high of $850 per ounce, after the Soviet invasion of Afghanistan and the Islamic Revolution in Iran. In May 1999, Gordon Brown triggered a fall in the price of gold after announcing that £4bn of gold reserves would be converted into euro, dollars and yen over the next few years.

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