Hold on tight as the world catches on to gold

I woke up on Friday morning to a conversation about gold on Radio 4's Today programme. Usually, when you hear about gold on the BBC, the conversation is led by someone who thinks the 12-year boom is less a bull market than a ludicrous bubble. Not this time.

Instead, the speaker was from gold website Bullionvault. I listened to this with a mild hangover, thanks to a late dinner party with a group that included an excellent but still reasonably mainstream fund manager. His portfolio is 10% invested in gold and the fact that we were talking about it didn't seem nuts to the rest of the party. I'm also getting an unusual number of emails about gold, including a rising number from non-financial friends, asking just how they go about buying it.

What's going on? According to HSBC's Charlie Morris, "precious metals are heading for a perfect storm" as the fundamental case for owning them "enters the mainstream". Morris compares the shift in sentiment to that around technology stocks in the 1980s and 1990s. Things kicked off at a relatively gentle pace. The Nasdaq rose at 6.5% or so a year, until 1994. As the industry and bit by bit the ordinary investor began to notice the move, that growth rate picked up to 14% for the next four years. Then as the sector's astonishing resilience during the Asian crisis was noted and everyone piled in the rate moved to 40% ... until the bubble peaked in 2000.

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"The longevity and stability of the trend ultimately became the perfect advertising mechanism for further investment," notes Morris. The result? The index rose 40 fold between 1985 and 2000, which was nice for people who got in early and managed to stay rational enough to get out.

Up until 2005, the bull market in gold was something of a slow burner. Prices rose at about 6% a year, before picking up the pace a little to 8%, just before the financial crisis. Now, we are at 14% and, says Morris, on the edge of a move to a "new trajectory".

It makes sense. Goldbugs have been going on for years about the unsustainable levels of sovereign debt across the western world. They've also been pointing out that default or currency debasement (printing lots of money to pay your debts) are the only possible ways out of these situations. Austerity has a long history of not working.

All that has changed is that the rest of the market has woken up to the dangers. Many European countries have been more or less bust for years. Now they are publicly so. Then there is the US. Again, goldbugs have been pointing to its grotesque levels of debt for years.

This week, the rest of the world finally noticed. Credit rating agency S&P has placed the US on 'creditwatch negative', saying that there is now a "substantial likelihood" that it will move its rating in the next three months.

We've become a bit blas about credit downgrades recently. But, if you'd told someone five years ago that US debt would ever be downgraded, they would have thought you utterly insane. It was unthinkable. It isn't now.

At the same time, it seems almost a given that, if growth continues to slow (which, given the nature of post-banking crisis recoveries, it will), there will be a third round of quantitative easing (QE3) in the US. There is also likely to be a version of QE2 here. And there's a chance that the European Central Bank, in one last effort to hang on to the euro, will accept that it has to allow its currency to weaken, too.

Congressman Ron Paul asked US Federal Reserve chairman Ben Bernanke this week why people hold gold. "As protection against what we call tail risks: really, really bad outcomes," he answered. He said this in a way that suggested these bad outcomes (default, currency collapse, hyperinflation and the like) are really unlikely. They aren't.

But it isn't just the metal itself you should look at. Gold mining shares have been trading too cheaply relative to the price of the metal. Silver is also worth considering now. Silver is tricky to forecast but its price has fallen very sharply from the highs of last year (around $50 an ounce) back to the mid $30s and that makes it look interesting relative to gold. Many watch the ratio of the two prices closely. Back in 1991, it hit 100 (one ounce of gold could buy you 100 ounces of silver). It is now 40 or so.

However, at the peak of the last bull market, the gold-silver ratio fell to 16. If the gold price stood still and the ratio went to 16 again, the silver price would hit $100 an ounce. But if the gold prices rises as well, then the final target for silver would be much higher.

Morris has just bought into a silver exchange traded fund (ETF). I'm not doing that silver makes me nervous (it is known as the 'restless metal'). But I am topping up my holdings in ETF Securities' Physical Precious Metals Basket ETF (LSE:PHPM).

If things play out with gold as they did with technology, we will soon have a real bubble on our hands. I'm looking forward to it.

This article was first published in the Financial Times