The real reason behind the soaring gold price

Why is the gold price soaring? Alan Greenspan blames investors' fear of global conflict, but the truth is that the former Federal Reserve Governor is more culpable than he would like to admit.

Former Federal Reserve governor Alan Greenspan is not a man to take retirement lying down more's the pity.

No sooner has he shuffled off the Federal Reserve board, than he's back doing what he does best passing the buck for his past mistakes.

In Mr Greenspan's first private sector speech, he claimed that the soaring gold price is being driven purely by fears of terrorism and "major geopolitical conflict".

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His comments on Japan should also give the smart investor cause for concern but more on that later...

Mr Greenspan blames gold's stratospheric rise on the fact that some people believe "that a nuclear weapon could be detonated within five years", said The Times. Nothing to do with inflation. Nothing to do with soaring demand for commodities.

This is a frankly breath-taking attempt at blame-shifting. There has never been a period of history free from global instability. Gold has only recently emerged from a two-decade bear market that started in 1980. During that time, we had the Cold War, the Falklands War, the first Gulf War, and the disintegration of Yugoslavia. That's just focusing on conflicts that involved the UK directly.

The prospect of a nuclear weapon going off in the imminent future has been a constant feature of all of our lives since they were first invented. So Mr Greenspan's argument doesn't really wash.

But he probably knows that. The trouble is, he can't admit to the real reasons for the surging gold price, because the trail leads straight back to his time as Federal Reserve Governor.

Gold is rising because people don't have as much faith in paper money as they used to. And the reason they don't have that faith anymore is because central banks around the world have been printing money and extending more credit just as quickly as they can.

From August 1987, when Mr Greenspan took the top seat at the Fed, to November 2005, the broadest measure of money supply in the US grew from $3.62 trillion to more than $10 trillion. (If you want to know more about what the M3 measure of money supply consists of, click here: Why the money supply made the news.)

So basically, the amount of money and credit available in the US almost trebled during the time that Mr Greenspan was Fed governor.

Now money is just like everything else. If it's in short supply, it becomes more valuable. If it's everywhere, it has much less value, which means you generally need more of it to pay for the things you want to buy.

At the moment, the Chinese are currently pumping out cheap socks and flat screen TVs as fast as Western consumers can snap them up. So prices of mass-produced consumer goods like these are either flat or falling.

But the prices of things that you can't rapidly make more of such as land and property have shot up dramatically, as an increased amount of money chases a static number of goods. The same goes for services that can't be outsourced to the Far East like haircuts or childcare.

Of course, one of the best things about gold, is that it's not easy to make more of it. That's why it is so attractive as a currency because it can't be pulled out of thin air, it physically restricts central banks from destroying its value.

The funniest thing about all this is that Mr Greenspan used to be an advocate of the gold standard. You can read more about this on our website, here: The mess Alan Greenspan leaves behind.

As for his comments on Japan according to The Times, Mr Greenspan also told investors at the forum that "after years in the wilderness, Japan had become a normal economy again."

The last stock market to get the Greenspan seal of approval was the Nasdaq right before the tech bubble burst. And true to form, the Nikkei 225 fell nearly 500 points the day after the Maestro's speech, though it recovered a little this morning.

We're not saying that Japan doesn't still look good long term. But after gains of more than 40% in the past year, the market may be ready to take a breather. Broker CLSA reckons that buying into the country just now is risky. The group expects a correction of around 13% to 22%, before the bull market picks up again in autumn.

Long-term investors should be able to ride out any short-term falls. But if you've yet to buy into Japan, you may find that better opportunities arise later this year.

You can read more about why it may be time to take a temporary step back from Japan in the current issue of MoneyWeek. Subscribers can read the piece online at our website, here: Take profits while political storms settle in Japan.

And if you're not yet a subscriber, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek.

Turning to wider stock markets...

The FTSE 100 closed 21 points lower at 5,725 as mining stocks slid amid falling metal prices. Kazakhmys fell 4% to 819.5p, BHP Billiton lost 4% to 976.5p, and Anglo American slid 4% to £20.12. Meanwhile, UK airport operator BAA soared 15% to 752.5p as Spanish construction giant Ferrovial said it was considering a bid for the group. For a full market report, see: London market close.

Over in continental Europe, the Paris Cac 40 closed 40 points lower at 4,895, while the German Dax was 6 points lower at 5,666.

Across the Atlantic, US markets headed higher on strong earnings from Cisco Systems and news that drugs giant Pfizer may sell or spin off its consumer products business. The Dow Jones surged 108 points to 10,858, while the S&P 500 jumped 10 to 1,265. The tech-heavy Nasdaq rose 22 to 2,266.

In Asian trading hours, oil was higher, trading at around $63 a barrel in New York. Brent crude was trading at around $60.70. Meanwhile, spot gold picked up to trade at around $558 an ounce.

In Asian stock markets, the Nikkei 225 gained 166 points to 16,439, rebounding from Wednesday's slump. Sony and Mitsubishi UFJ Financial were the main risers.

And in the UK at noon today, the Bank of England will announce its latest decision on interest rates. The bank is likely to keep the key rate at 4.5%.

And our two recommended articles for today...

How central banks have held gold down

- Gold fans have always claimed that central banks have been artificially suppressing the gold price, but they have usually been dismissed as deluded conspiracy theorists. But now a major investment bank has published a report claiming exactly that. Adrian Ash of The Daily Reckoning explains why this means that now, more than ever before, you should be buying gold - to learn more, click here: How central banks have held gold down

An investor's shopping list for the next ten years

- People who lived through the Great Depression never lost their mistrust of shares, while those who lived through the '80s bull market don't believe in anything else, says True Wealth's Dr Steve Sjuggerud. And that means that contrarian investors can learn to take advantage of this investment 'generation gap'. To find out which investments are likely to outperform over the next ten years, click here: An investor's shopping list for the next ten years

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.