Why wise men will be thinking about gold investments now

Gold now is not only cheaper than it was for the last 40 years of the 19th century; it is back to the average price of the last 130 years

Gold, frankincense and myrrh: of the wise men's three gifts only gold has retained, through two millennia, its place in our imagination. "Gold cards", "gold service", "gold accounts" - banks and the rest of the commercial world still use the image to proclaim quality. But if the aura continues, for the last 15 years at least, gold has been a poor investment. Not only does it not pay interest, and through the 1980s real interest rates have, unlike in the 1970s, been positive. The long-term trend of inflation seems to be down and one of the prime reasons for people holding gold has been as a protection against debasement of the currency.

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.

Arts and Entertainment
The cast of The Big Bang Theory in a still from the show
tvBig Bang Theory filming delayed by contract dispute over actors' pay
England celebrate a wicket for Moeen Ali
sportMoeen Ali stars with five wickets as Cook's men level India series
Morrissey pictured in 2013
peopleGuitarist, who played with Aerosmith, Lou Reed and Alice Cooper among others, was 71
ebookA unique anthology of reporting and analysis of a crucial period of history
Arts and Entertainment
High-flyer: Chris Pratt in 'Guardians of the Galaxy'
filmThe film is surprisingly witty, but could do with taking itself more seriously, says Geoffrey Macnab
Life and Style
food + drinkVegetarians enjoy food as much as anyone else, writes Susan Elkin
Life and Style
lifeDon't get caught up on climaxing
Life and Style
Arts and Entertainment
Harry Potter (Daniel Radcliffe), Hermione Granger (Emma Watson) and Ron Weasley (Rupert Grint)
newsBloomsbury unveils new covers for JK Rowling's wizarding series
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

1st Line Support Technician / Application Support

£20000 - £24000 per annum: Harrington Starr: A leading provider of web based m...

Team Secretary - (Client Development/Sales Team) - Wimbledon

£28000 - £32000 per annum: Ashdown Group: Secretary (Sales Team Support) - Mat...

Accountant / Assistant Management Accountant

Competitive (DOE): Guru Careers: We are looking for an Assistant Management Ac...

Senior Investment Accounting Change Manager

£600 - £700 per day + competitive: Orgtel: Senior Investment Accounting Change...

Day In a Page

Save the tiger: The day America’s love of backyard tigers led to a horrific bloodbath

The day America’s love of backyard tigers led to a horrific bloodbath

With only six per cent of the US population of these amazing big cats held in zoos, the Zanesville incident in 2011 was inevitable
Samuel Beckett's biographer reveals secrets of the writer's time as a French Resistance spy

How Samuel Beckett became a French Resistance spy

As this year's Samuel Beckett festival opens in Enniskillen, James Knowlson, recalls how the Irish writer risked his life for liberty and narrowly escaped capture by the Gestapo
We will remember them: relatives still honour those who fought in the Great War

We will remember them

Relatives still honour those who fought in the Great War
Star Wars Episode VII is being shot on film - and now Kodak is launching a last-ditch bid to keep celluloid alive

Kodak's last-ditch bid to keep celluloid alive

Director J J Abrams and a few digital refuseniks shoot movies on film. Simon Usborne wonders what the fuss is about
Once stilted and melodramatic, Hollywood is giving acting in video games a makeover

Acting in video games gets a makeover

David Crookes meets two of the genre's most popular voices
Could our smartphones soon be diagnosing diseases via Health Kit and Google Fit?

Could smartphones soon be diagnosing diseases?

Health Kit and Google Fit have been described as "the beginning of a health revolution"
Ryanair has turned on the 'charm offensive' but can we learn to love the cut-price carrier again?

Can we learn to love Ryanair again?

Four recent travellers give their verdicts on the carrier's improved customer service
Billionaire founder of Spanx launches range of jeans that offers

Spanx launches range of jeans

The jeans come in two styles, multiple cuts and three washes and will go on sale in the UK in October
10 best over-ear headphones

Aural pleasure: 10 best over-ear headphones

Listen to your favourite tracks with this selection, offering everything from lambskin earmuffs to stainless steel
Commonwealth Games 2014: David Millar ready to serve up gold for his beloved Scotland in the end

Commonwealth Games

David Millar ready to serve up gold for his beloved Scotland in the end
UCI Mountain Bike World Cup 2014: Downhill all the way to the top for the Atherton siblings

UCI Mountain Bike World Cup

Downhill all the way to the top for the Atherton siblings
Save the tiger: The animals bred for bones on China’s tiger farms

The animals bred for bones on China’s tiger farms

The big cats kept in captivity to perform for paying audiences and then, when dead, their bodies used to fortify wine
A former custard factory, a Midlands bog and a Leeds cemetery all included in top 50 hidden spots in the UK

A former custard factory, a Midlands bog and a Leeds cemetery

Introducing the top 50 hidden spots in Britain
Ebola epidemic: Plagued by fear

Ebola epidemic: Plagued by fear

How a disease that has claimed fewer than 2,000 victims in its history has earned a place in the darkest corner of the public's imagination
Chris Pratt: From 'Parks and Recreation' to 'Guardians of the Galaxy'

From 'Parks and Recreation' to 'Guardians of the Galaxy'

He was homeless in Hawaii when he got his big break. Now the comic actor Chris Pratt is Hollywood's new favourite action star