Ambrose Evans-Pritchard: Flight to gold as investors lose faith in money


By Ambrose Evans-Pritchard
The Telegraph, London
Sunday, January 6, 2008

The last time gold touched $850 an ounce, the world was visibly spiralling out of control.

Soviet tanks had just rolled into Afghanistan. The Mullahs had seized US hostages in Iran. Pax Americana was on the ropes, and so was capitalism. Inflation had reached 14 per cent in the United States.

The final spike in bullion occurred when the Hunt brothers tried to corner the silver market, forcing up gold in tandem through arbitrage links. It collapsed within days.

If you strip out the Hunt anomaly, it is fair to say that gold established a "safe-haven" level of $600 -- or $1,500 in today's money -- that roughly lasted through the final phase of the Carter malaise, the oil shock, and the collapse of confidence in the monetary order.

By this benchmark, last week's jump to $869 looks tame. Yet gold is undoubtedly flashing warning signs. The price has jumped 42 per cent since the US credit markets suffered their heart attack in August. It has tripled since Gordon Brown sold over half Britain's reserves, deeming it a barbarous relic. That conceit has cost taxpayers L3.4 billion, after adjusting for returns from dollar, euro, and yen bonds.

The mounting risk that Pakistan's nuclear weapons could fall into the hands of al-Qaeda is playing a role. So are fears that Western leaders have no credible answer to the banking crisis as it drags on for month after month.

Note that gold smashed the 28-year record just days after the European Central Bank launched its monetary "shock and awe," showering half a trillion dollars on the banks, with parallel moves by the Fed, the Bank of England, and the Swiss. Clearly, a small army of investors is betting -- rightly or wrongly -- that our debt-bloated democracies are now too decadent to take their punishment. The elites will opt for the easy path of reflation to postpone the day of reckoning.

Ben Bernanke, the Fed chief, is viewed as an inflationist. He once talked of dropping bank notes from helicopters. Loose words have consequences if you are a Fed governor.

"The central banks are flooding the market with paper," Peter Hambro of Peter Hambro Mining said. "Does anybody now take the dollar, the euro, or the pound seriously? People are turning to gold because it is the only hard store of value," he said.

Joachim Fels, bond guru at Morgan Stanley, said that the central banks will tolerate an upward creep in the underlying level of inflation because the pain required to kick the habit at this late stage is deemed too high. "I strongly doubt that they will tighten the screws. I expect 2008 to mark the beginning of another global liquidity cycle."

Blame the return of 1970s stagflation. The China effect has turned malign, pushing up global prices. The easy trade-off between growth and inflation is over. All choices are now bad. Infecting everything is the looming end to US dollar hegemony. Mid-East and Asian states are importing America's bailout policies through their currency pegs (or dirty floats), stoking an inflationary fire. Prices are now rising 14 per cent in Qatar, 10 per cent in the UAE, 13 per cent in Vietnam, and 6.9 per cent in China. The pegs are near snapping point. Bretton Woods II is dying.

For a while Asia, Russia, and the petro-powers seemed happy to accept the euro as the anti-dollar. Long-term capital flows into the eurozone reached a net E200 billion in the first seven months of 2007, according to BNP Paribas. Then the money dried up.

Perhaps Asians were shocked to learn that German, French, and Dutch banks had gorged on sub-prime debt, or perhaps they began to take a closer look at Europe's fertility rate and vanishing youth, or woke up to the deflating property bubble in Spain. Yes, the euro reached record highs in the autumn, but this was driven by hot money flows. Such fickle finance will drain away as soon as the ECB hints at rate cuts.

So are the new powers turning to gold instead, mistrusting the euro as much as the dollar?

Their footprints have not yet shown up in the IMF reserve data, but there can be long delays, and China does not report data. Vladimir Putin has told Russia's central bank to raise the gold share of its $469 billion reserves to 10 per cent. We know that those Asian and oil states now holding most of the world's $6.6 trillion reserves possess very little gold, yet most have an historical affinity for it. Draw your own conclusion. We know too that the little guys are buying defiantly, at last able to invest in gold through exchange trade funds (ETFs) on the main bourses. The ETF holdings have reached 834 tonnes, putting them in seventh place ahead of the Bank of England, the ECB, and Japan.

Gold's latest surge has caught the bullion banks off-guard. Most expected the price to fall back at the end of India's Diwali marriage festival. Speculative "longs" on New York's Comex market exceed levels that have often led to a sharp selloff in the past. Jewellery demand -- still 80 per cent of the market -- has stalled. With all the moons aligned for a correction, Goldman Sachs advised clients to go "short" in November. That was $60 ago. Ouch.

The gold bears may yet smile. James Steel, an analyst at HSBC, said gold is shackled to oil since the commodity funds ($140 billion) allocate fixed shares to each component.

Energy makes up 65 per cent of the weighting, so the indexes must buy gold whenever oil shoots up -- as it did last week, kissing $100 a barrel. "The oil/gold correlation has risen 0.9 since the emergence of these funds, which is very high," he said.

So what happens if a slump chills oil?

We will then learn whether gold is a commodity, or once again a currency.

"We think gold is fundamentally overvalued by about $150, but that can go on for a long time," John Reade, the precious metals chief at UBS and top forecaster this year. "A lot of our clients have been buying gold since the credit crunch because they think central banks will respond with aggressive monetary easing. If that becomes a mainstream view, gold will soon have four figures on it. The feeling is that there is a lot of money around, and not much gold," he said.

Indeed. Mining bosses complain that the earth's crust is yielding less gold. Output in South Africa has fallen to the lowest since 1932. Canada has passed peak output. Gregory Wilkins, head of Barrick Gold, says, "Global mine supply is going to decrease at a much faster rate than people generally believe."

In the Middle Ages gold fetched nearly $3,000 an ounce in real terms. The price fell to nearer $550 when Spain flooded the world with Aztec and Inca riches, and there it hovered for three centuries.

But the modern era has been an aberration. Supply is exhausted. Perhaps we should now regard the Middle Ages as the proper benchmark price. One thing is certain: Gold will outperform paper as long as governments keep increasing the global money supply 15 per cent a year.

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