Is it still worth buying gold?

This coming May will mark ten years since Gordon Brown chose to sell well over half the UK's national gold reserves some 415 tonnes all told at what would prove to be rock-bottom prices.

Those British investors who saw life in the metal back then have tripled their money. Last year alone, the gold price in sterling rose by 40%, beating all other investments bar the Japanese yen and an early punt on Portsmouth winning the FA Cup.

So is it too late to buy?

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Well, global gold mining supply, which peaked in 2003, fell yet again last year. Growth from China (now the world's number one producer) was more than offset by declining ore grades, shrinking margins and energy instability in South Africa, where annual output has halved from a decade ago.

Thanks to the financial crisis, meanwhile, junior gold miners always a high-risk proposition continue struggling for finance, and many are mothballing young projects. The last true 'elephant' find came more than two decades ago at Peru's Yanacocha. And all this while, the industry continues to miss a 'lost generation' of geologists, mine engineers and metallurgy experts whose mathematical skills earned them far more in the City of London than hard-hats could pay.

On the other side of the trade, gold investment demand leapt in 2008 as the financial crisis deepened, with a significant shift (particularly by high-net-worth individuals) from paper certificates and derivative schemes to owning physical metal outright.

Why? Because amid the banking collapse and stock-market wipe-out, holding a high-value asset, free from the risk of default, only became more attractive. The apparent threat of 'deflation' may only make gold more attractive again. Because a deflation of wages and prices in fact makes credit default the investor's number one terror.

Whereas the obverse risk... the threat of soaring inflation? We'll get to that in a moment.

At the retail end of the market, a surge in gold coin demand came as the dollar price first slid from its peak of $1,032 per ounce in March the top not coincidentally reached when Bear Stearns collapsed into the warm, tax-funded arms of a takeover by JPMorgan. And then, as the dollar-gold price began to struggle and even while the gold futures market shrank by one-half (caused by hedge funds and other leveraged speculators having their credit lines pulled by the ailing investment banks) the surging bid for physical gold caught refineries and mints napping once more.

Shortages continue worldwide today, with new buyers having to wait six to eight weeks for delivery. The premiums charged on retail products have jumped accordingly, averaging 6% and above in the US and Europe. Jewellery buying in the key markets of India and south-east Asia also remained strong in the back-half of last year, slipping back only to 2006 levels despite the month-on-month records in rupee gold prices.

Scrap supplies from Middle East owners, meanwhile, dried up in the summer, exacerbating the shortage of ready material for fresh investment supplies. Yes, scrap supplies picked up (and strongly) in the back-half of 2008. But gold sales from central banks sank to a ten-year low, as 'prudence' made a shock return to official policy, if only in central-bank reserves management.

You see, the fifteen members of the Central Bank Gold Agreement (CBGA) sold a mere 357 tonnes of the stuff in the year to September 2008... almost 30% below their agreed ceiling. World number two gold hoarder the Deutsche Bundesbank even went as far as to publically refuse a call to help balance the country's federal accounts by selling gold from its vaults, restating instead gold's key role in building "confidence and stability" in official currency.

Sadly for cash savers, interest-rate policy now wants to annihilate both confidence and stability in all government paper. And looking ahead to gold in 2009, last year's collapse of official interest rates down to an average nudging 1.0% for cash savers in the G7 top economies might prove a tough hangover to shake.

So what next?

Well, if gold only gains during inflation, then that's what we must have been suffering since the 'Brown bottom' of ten years ago an inflation in house prices, consumer debt and credit derivatives that finally burst into the consumer price data in 2008. The gold price in sterling, for instance, has since returned 13% per year on average. Bank of England base rate, in contrast, has held just 1.9% above inflation on average less than half the level of real returns paid during the 1980s and 90s.

Now as 2009 begins, real interest rates have been slashed well below zero in the UK, Japan, Switzerland, Taiwan and United States... and it's here you'll find the one common factor between this decade's bull market in gold and the 20-fold rise of the Seventies. Because low returns paid to cash remove the one big disincentive to using gold to store wealth: the fact that it doesn't pay you an income.

If the race is on to pay zero to cash savers, then ever-more cash savers might want to reach the finish line first... and jump straight into that non-paying, non-defaulting investment asset the same asset which Gordon Brown thought had no further use back in May 1999: gold bullion.

Adrian Ash is editor of Gold News and head of research at BullionVault

A version of this article was first published in the Daily Telegraph