Is it time to go contrarian on gold?

When I started suggesting that you buy gold back in 2001 or so having met a particularly convincing gold bug the idea was met with almost universal derision. Still, nothing succeeds like success and so it is with gold. Last weekend's papers were full of commentary from fund managers explaining why now is the time to buy.

When gold was trading at $250 an ounce they would have nothing to do with it. But now it has quadrupled they are climbing over each other to stuff it into their portfolios and quoting the phrases the gold bugs have been wearily repeating for years. "Gold is no one's liability." "Gold depends on no one's promise to pay." "Gold carries no credit risk." "Gold cannot be inflated (you can't print more of it)." "Gold's value cannot be altered by government decree."

Odd isn't it, this change of heart? Still, just because these words are now being mouthed by every nitwit in the market doesn't make them wrong. The fact remains that gold is the best insurance there is against horrible things happening in financial markets and to currencies. And horrible things are happening. The sudden collapse of Bear Stearns has been deeply unsettling. And the market is now, with good reason, a nervous wreck. We're in a vicious cycle where, as John Hardy of Saxo Bank puts it "the move is what generates the move."

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As risk spreads rise the flight to safety gathers momentum, hence further pushing up risk spreads. It is a "good old fashioned 19th century style panic." Can the Fed rescue the situation? You can't say they aren't giving it a good go what with the endless injections of cash into the market.

But given the big questions still out there (Who's next? Where will the money come from to bail anyone bigger than Bear out?) it is hard to see how they can halt the flight to safety and hence keep pretending this is a liquidity crisis rather than a solvency crisis. Under such circumstances why wouldn't you want to hold gold?

We also have to take momentum into account. If all these fund managers are going to put their money where their mouths are and actually own a proper amount of gold, the price will surely keep rising simply as a consequence of their buying frenzy that's going to push the price up in itself. Gold has had an amazing run and it would be foolish to expect it to continue to rise at anywhere near the same speed as it has in the last year. However given that the very thing we use it to insure against is now happening (i.e. the financial system is imploding) I suspect it would also be foolish to come over all contrarian and sell out now.

First published in The Evening Standard 18/3/08