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Business Comment

Satyajit Das: Is this the return of a golden age... or are we all just running scared?

Midweek View: An investment made in bullion in the 15th century would have lost 90 per cent of its value over the next 500 years

In Germany, gold is now available from vending machines in airports and railway stations – Gold to Go. Shoppers can buy a 1 gram wafer of gold or a larger 10g bar. Seeking safety for their savings, individuals purchased 150 tonnes of gold, mainly in the form of coins.

Investors poured money into special funds known as exchange traded funds (ETFs), which pool investor monies, to buy over 1,000 tons of gold. Having earlier sold off their holding, some central banks are now re-building their gold reserves. The world has remembered J.P. Morgan’s words to Congress in 1912: “Gold is money. Everything else is credit.”

Since the replacement of the gold standard with the dollar standard, the gold price has fluctuated widely. In January 1980 it reached a high of $850 per ounce reflecting inflation and economic uncertainty. Subsequently, the recovery of the global economy saw the price fall for nearly 20 years, to a low of $253 per ounce in June 1999.

From 2001, the price began to rise due to increased demand, especially from emerging nations. In 2007/2008, gold received an additional boost from the onset of the global financial crisis. Concern about a banking collapse drove prices higher, to peak at over $1,913 per ounce in August 2011. Gold bugs speculate about a new age of gold.

In reality, the rise was driven by fear. The depth of the financial crisis, concern about other assets including once risk-free governments bonds, and a fragile banking system prompted a flight to gold. The monetary policies of governments and central banks, emphasising low interest rates and printing money to restart the global economy, also underpinned the gold price.  A weak US dollar and the questionable prospects of other major currencies, such as the euro and yen, also drove demand for gold as a de facto currency.

For investors, buying into gold is not without problems. Shares in gold mining companies may not provide the sought-after exposure to gold prices. The value of mining companies behaves more like shares than the gold price.  Most investors prefer direct investment to the precious yellow metal. Increasingly, investors use gold ETFs, a mutual fund or unit trust which is listed and tradeable on a stock exchange. Investors purchase fractional shares in the ETF which then invests the money raised in gold. Some ETFs invest in the metal itself. Others synthesise the exposure to gold using instruments linked to the gold price, such as gold futures and derivatives.

Where the ETF uses derivatives and other financial instruments it is exposed to the risk of default by the financial institutions with which it contracts. Even where the funds are invested in physical gold, the metal is held via custodians, often financial institutions, exposing them to the failure of these entities. This is ironic given the fact the investment in gold is specifically motivated by fear of the failure of the financial system.

Investors also worry about the risk of confiscation of gold holdings. In reality, any government can confiscate anything  they want to in times of economic emergency. In 1933 President Roosevelt prohibited the private holding of gold and required US citizens to turn over their gold bullion or face a $10,000 fine (equivalent to around $170,000 today) or 10 years imprisonment.

Gold is not itself a great store of value, at least over long time periods.Gold bugs excitedly speculate about prices reaching $2,300. But even at that price gold would merely match its January 1980 peak price after adjusting for inflation; in other words, the holder had earned nothing on the investment over almost 30 years! 

The gold price adjusted for inflation is the same as the price in the Middle Ages. Dylan Grice of Société Générale summed up the case for gold as a store of value in the following terms: “A 15th century gold bug who’d stored all his wealth in bullion, bequeathed it to his children and required them to do the same would be more than a little miffed when gazing down from his celestial place of rest to see the real wealth of his lineage decline by nearly 90 per cent over the next 500 years.”

But as Warren Buffet observed, if stock investors are driven by optimism about prospects then “what motivates most gold purchasers is their belief that the ranks of the fearful will grow.” In economic chaos, war or collapse, gold reappears, reasserting its grip on humanity.

Satyajit Das is a former banker and the author of 'Extreme Money' and 'Traders Guns & Money'