The longer-term trends in the gold price are set out in the graphs: on the left what has been happening to the actual price since 1970, and on the right the real price since 1863, with the dollar price deflated by the US consumer price index, and 1863 price taken as base 100. The message is pretty clear. In money terms there was the re-rating of gold during the 1970s, corresponding with the decade of inflation, but since then, even in money terms, the gold price has fallen steadily.
In real terms the drop is sharper, as shown in the other graph. The average real price for gold, against that 1863 base, is just over 60, pretty much the same as the present price of around $360 an ounce. In other words, gold now is not only cheaper than it was for the last 40 years of the 19th century; it is also back to the average price of the last 130 years.
When you try to work out real values for something as volatile as gold, you have to try to establish what constitutes normality. Clearly the experience of the last 30 years, the great inflationary boom, is very abnormal. Inflations like that only occur every three or four hundred years: the only previous period in English history since 1250 when there was rapid inflation was between about 1530 and 1600. Then prices rose roughly 10-fold, as they did between 1960 and 1990. All other inflations have seen prices perhaps double - and then that rise be largely reversed. If normality is stable prices, and there is a reasonable expectation that this will continue for the foreseeable future, what hope is there for another boom in the price of gold?
It is very hard to see another boom like that one shown in the spike on the right hand graph. In the view of the editors of The International Bank Credit Analyst, from whom that graph is taken, gold will indeed continue to underperform other assets and its real price will erode. They conclude that despite the recent fall in prices, it is not a good time to get back into gold. That the real price is back close to its US 1863-1996 average does not mean that it won't continue on downwards, just as it did between 1863 and 1920, and 1941 and 1971.
That is probably right - but only probably. Remember that investment in gold is an insurance policy. If currencies or other financial assets, for whatever reason, become untrustworthy, gold will retain at least some of its value. It may sound primitive, but a lot of people in the world do believe (with some justification) that if they have a few gold bars under their bed at least they won't starve.
Looking ahead there are, as always, two views. One, and to judge by the gold market's performance in recent months, this is the dominant one, is to say that the period of stability into which we are moving renders gold unnecessary. The major currencies are stable, and offer solid returns in the shape of positive real interest rates. Other financial assets, in particular equities, offer an opportunity to share in the growing wealth of the world. Inflation, already beaten in the developed world, will soon be on the retreat in the developing countries and in the former communist countries too.
Further support for this view comes from a look at the physical market. For nearly a decade gold production has failed to keep up with rising demand. Between 1986 and 1995 demand rose by 49 per cent, driven principally by rising wealth in China and India. But while these sources of demand seem likely to continue to grow, so too may production. The former Soviet Union is likely to boost supply, and traditional producers, in particular South Africa, could also increase supply. Production there has actually fallen by about 20 per cent over the last three years, and the government is seeking ways of encouraging a revival. New capacity tends to have low production costs, so investment will continue even if the price continues to fall. Finally, there is the overhang of central bank gold, including gold held in the coffers of the International Monetary Fund, and the possibility some of this will be sold.
There is, however, an alternative argument, which runs like this. True, the long-term trend of gold may be flat, but it is not necessarily downwards. On a long historical view the present price is not too bad. There are a number of possible factors which in the coming years might make gold more attractive, irrespective of what happens to inflation.
For a start we should not be so confident about the security of national currencies. One of the most important world currencies, the German mark, may disappear in the next five years. The yen is liable to become weak as Japan's ageing population runs down external assets to help pay for health care. Even the dollar carries risks, for in a decade the US has moved from being the world's largest net creditor nation to the world's largest debtor.
Add in the fact that the governments of all developed countries (with the possible exception of the UK) have accumulated large, unfunded pension liabilities, as well as significant public sector debt, and the underpinning of the main currencies may not be so secure. As for other assets, in particular equities, values are quite high at the moment. At some stage in the next few years there will be a readjustment, maybe a severe one, and as doubts and fears rise expect some of the clever money to be shifted to gold. Not very much needs to be shifted to have a sharp impact on the price. And as noted above, in much of the fastest-growing countries, gold has a continuing allure.
Which view is right? My own suspicion is the balance of probability is that the first, the bear case, will be the dominant one for the next decade or more. But there is a strong minority possibility that at some stage in the next 10 years there will be some upheaval, some discontinuity, in the world economy which we cannot predict. And then, for a while a least, gold will again be king.