Is the bull market in gold finished?

published 22 June 2006

In December 1997, the Financial Times ran an editorial entitled "The Death of Gold". The obituary must have felt as safe back then as it looks stupid today. Gold had slipped into a bear market nearly two decades earlier. Only a crackpot could have believed it would ever rise from its grave. The time to buy was drawing near.

You couldn't fault the FT's logic. Gold's famous spike to $850 an ounce in 1980 had come when Russia invaded Afghanistan and the overthrow of the Shah in Iran drove oil prices to record highs. But the Soviet Union had since collapsed, signalling "the end of history", as Francis Fukuyama put it in his best-selling book, as oil and mineral prices had sunk. Stocks and bonds, meanwhile, just kept rising. That left the "safe haven" metal more embarrassing, more shamefully out of step with the times than voting for John Major's sleazy and incompetent Tories.

But gold refused to keel over and die. During the next six years, it crept 39% higher, but the FT only wheeled it from the mortuary to the hospice, declaring in April 2004 that "the end of gold as an investment [had] come a little closer" when NM Rothschild quit the London Gold Fix. Since then, the golden zombie has more than doubled in price. Earlier this year, it hit a 25-year high in terms of the pound in your pocket.

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When the Bank of England tried vampire-killing in June 1999, the Old Lady of Threadneedle Street dumped 395 tonnes of supply on the market. She also let in the searing daylight of a public auction, announced in advance, that gave bullion traders two months to push the price of gold lower. It sank to its knees. But besides costing the taxpayer £4.7bn at today's prices, the Bank of England's move prompted by Gordon Brown at the Treasury only spurred contrarian investors to start buying. "Gold is a must buy for prudent investors today," said the Fleet Street Letter in July 1999, advising its readers to take advantage of the Government's "cynical and expensive sell-off". Fast forward to Thursday, 12 May 2006, and gold traded above £384 ($720) per ounce, up more than 150% from its low in sterling terms. That same week, however, gold also made an appearance in the Daily Mail and on Radio Four. Allister Heath in The Spectator wrote that "the price of gold will continue to rise". The price duly began falling.

Along with the FTSE, copper, mining shares and emerging markets, gold has now dropped more than 10% from its peak of a fortnight ago. But still the new consensus that gold is going to rise keeps building. This week, John Plender in the FT said it "is in a long-run bull market". The Guardian's Larry Elliot agrees, as does Anthony Hilton in the Evening Standard. Suddenly, gold seems to be the height of fashion.

Buying gold is financial speculation in its purest form, a gamble that war, stockmarket meltdown and runaway inflation happen more often than most investors think. Safe haven be hanged "owning gold is about making financial crises fun", says Paul Tustain of BullionVault.com. But while you await that "delightful Armageddon that will propel gold to $3,000 an ounce", as Eric Fry recently put it in The Daily Reckoning, gold is a losing bet.

"There is little to analyse," as John Hathaway of Tocqueville Asset Management has said. Sitting at No.79 in the periodic table, gold doesn't corrode or tarnish. Thanks also to its rarity, scarcely three parts per 100 million in the earth's crust, it has therefore been deemed throughout history to hold its value. According to a study by the World Gold Council, one ounce of gold would buy the same amount of bread as it did at the time of Nebuchadnezzar, more than 2,500 years ago. But you can now buy nearly three times as many sandwiches with an ounce of gold as you could when the WGC published its study in 1998. Given that the metal has a long-run tendency "to return to an historic rate of exchange with other commodities", as the report says, either the metal should now fall back or the price of bread will rocket.

A severe correction in gold was long overdue. After building a remarkably steady and solid uptrend for more than five years, its sudden spike beginning in March took out 25-year highs in all major currencies, and left traders with little technical data on their charts to judge what might happen next. The air is so thin at these levels, in fact, that gold could drop as low as $590 an ounce before finding serious support.

But "bad news for investors can be good news for consumers", as the Times of India notes, and jewellers across the world will welcome lower gold prices. Indian jewellers in particular had been hit by the rising price of gold India is the world's largest consumer market for gold. It became almost 9% more expensive during the first quarter of 2006 in terms of the rupee. Demand from India's jewellers dropped 38% from a year earlier, according to data from the GFMS consultancy. But by early spring, and with a major Hindu festival-day due at the start of May, it seems that India's jewellers, who had been waiting for a pullback in the price of their raw material, finally bit the bullet ahead of Akshaya Tritiya, when it is considered good luck to buy gold. And this year, says the Times of India, all of Bangalore's 2,000 gold shops "were choc-a-bloc" with customers. Across the four states of south India, 70,000kg of gold jewellery was sold in one day, with the number of shoppers up 50% from last year. Chinese jewellery demand may also have risen sharply at the start of May. The Golden Week' holiday in Hong Kong attracted 100,000 shoppers to a night fair'. According to Lukfood Holdings International, jewellery sales increased by 10% from last year.

But if physical demand from India and China has spiked this month, demand from the derivatives market in the US is about to turn lower. At the end of last week, 83% of the gold futures market was bullish, says the Commitment of Traders data. But the commercial traders, often known as the "smart money" due to their uncanny knack of making the right calls at the right time, were bearish by a ratio of three to one. After the huge run-up in prices this spring, they could be right. History says the price could lose up to 40% before rising strongly again.

During its last major bull run, gold suffered a 19-month correction. It had risen eight times over between 1971 and the end of 1974, but as the US pulled out of Vietnam and the International Monetary Fund sought to stabilise the global financial system, investors who were late to the party found they had missed all the fun. The metal sank from $189 per ounce to $109 by the summer of 1976. Yet over the half-decade that followed, the average monthly price rose again to stand three times higher. It spiked to offer a massive 521% gain when Russia invaded Afghanistan.

Of course, anyone who bought on the sound of gunfire in January 1980 is still waiting to break even in dollar terms. And adjusted for inflation, long-suffering US gold bugs need the price to hit $2,088 per ounce, according to the maths of Chris Puplava on FinancialSense.com. But "instead of dwelling on the dollar price of gold", says Puplava, "we should be talking about the depreciation of the dollar". British investors should dwell on the depreciation of the pound in their pockets, too.

Since gold's last record peak in January 1980, inflation in the UK has eroded 76% of the pound's purchasing power. Add to that the seven-fold increase in average house prices and you can see how little the pound now buys in comparison. You might not think that matters; so long as the stockmarket and house prices keep rising what's wrong with a few more pounds, dollars and euros flooding the world to help keep all boats afloat? The world's central bankers agree. Eurozone money supply is now growing by 7% per year, US money supply is rising nearer 9% per year, the supply of Chinese yuan is up 16% and UK money-supply growth has been averaging 10.2% for the last two years. But global GDP growth in 2006 is forecast by the IMF at 4.75%. That means an oversupply of money that will only erode the value of money further.

Dr Marc Faber in the latest Gloom, Boom & Doom Report, "all assets could rise in nominal terms, but some will obviously depreciate against sound money' whose supply cannot be increased at will." In other words, any gains you make in stocks, bonds or property could be rendered meaningless in real terms. What's more, so far, "most investors have largely missed the bull market in oil and gold", says Faber. He cites the still-modest weighting of energy shares in the S&P 500 and net outflows from a major gold fund. Yes, new vehicles such as the Lyxor gold bullion share (LSE:GBS) have encouraged new retail investment. But the fund has a market cap of less than £1bn today hardly the stuff of bubble tops.

"I first tried to get clients to begin building gold positions two years ago," says one UK investment adviser. "No takers!" The mass of investors still need convincing. Until they start clambering over one another to buy gold on news of runaway inflation, war in the Middle East, a new oil crisis, or the collapse of paper-asset values, the contrarian signals still say "buy". Aggressive traders might well wish to sell gold short using a tight stop-loss over the next few weeks and months. But long-term investors awaiting that "delightful Armageddon" are advised to keep holding. If the price plunges, buy more.

Jason did not take his Argonauts in quest of the fleece made of paper. It's gold people have long wanted. While the list of paper assets that went bad is as long as financial history, never did a single gold coin go bust. Gold isn't perfect money (it goes up and down against other things), but it's the most perfect money that ever existed. Bankers have experimented with pure paper money, unbacked by gold, but almost always regretted it. Now they're at it again, in a breathtaking way. Since 1971, the world's paper currencies look only to the dollar for backing. Where does the dollar look? Nowhere. We have a faith-based system, backed only by faith in central bankers' judgment and integrity. Say the words out loud and you'll cringe. Everyone knows bankers aren't to be trusted.

A gold-backed dollar in 1913 was worth about as much as a gold-backed dollar a hundred years earlier. But in that very year, the Federal Reserve System, America's central bank, was set up, among other things, to protect the value of the dollar. Ninety-three years later, the banker-backed dollar is worth a nickel in 1913 terms. Barely. Alan Greenspan has been proclaimed the greatest central banker who ever lived. Yet, during his time at the Fed alone, the dollar lost half its value. Investors' faith in paper is ebbing. They're looking at the exploding supply of money and credit. Their jaws drop as they watch copper and oil prices. They must wonder: what are the dollar, pound, euro and yen really worth? No one knows. But if the history of paper money is any guide, much less than you think.

Even the most dismissive financial advisor couldn't argue with putting 5% of your investment cash into physical gold, the metal itself. Often called a "Golden Anchor", it will act as a ballast for your portfolio during times of trouble in the stock and bond markets. You can buy solid gold coins to store and insure at home; the South African Krugerrand costs around 7% more than the spot price quoted in your newspaper. Or you can track the price of gold with the Lyxor Gold Bullion Share (LSE:GBS); it costs 0.4% in management fees, on top of your stockbroker's charges. Alternatively, you can buy gold vaulted in Zurich, with no middle men, using BullionVault.com.

The HUI Gold Bugs Index consists of 16 mining stocks that sell no more than the next 18 months of their production forward, giving you direct exposure to the gold price both up and down. The HUI includes Newmont Mining (NYSE:NEM), and GoldCorp (TSE:G), which has the lowest production costs of the million-ounce-per-year miners. Its stock has dropped 25% in the last two weeks. Aim-listed Peter Hambro Mining (Aim:POG) rose nearly 20 times over between 2002 and the start of May this year. It has since fallen back 35%, taking its market cap beneath £1bn for the first time since February.

Only for adrenaline junkies with money to burn. Most commonly based in Vancouver, Canada a stock exchange discredited by a series of mining stock scams in the 1980s the explorer's primary aim is to find and prove a sizeable gold deposit, and then sell out immediately to a larger gold-mining firm. It rarely happens. But striking gold can mean a huge return for foolhardy investors. Anatolia Minerals (TSE:ANO) has risen by 700% since legendary gold analyst Doug Casey first tipped it in 2001. Earlier this year it announced a multi-million-ounce find in Turkey. See Caseyresearch.com for more information.

Adrian has written all things gold related from if it’s worth buying, what the real price of gold should be and what’s the point of gold for MoneyWeek. He has also written for other leading money titles on his gold expertise including Business Insider, Forbes, City A.M, Yahoo Finance and What Investment Magazine. Now Adrian is head of the research desk at BullionVault, a physical market for gold and silver for private investors online.