Why should you buy gold?

US bank Netbank 'did a Northern Rock' last week. And whilst its collapse may not have have made a big splash over here, its yet another blow to confidence in the financial system. And another reason to buy gold.

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A US bank did a Northern Rock at the end of last week.

The story didn't exactly make a huge splash on this side of the Atlantic. That's probably partly to do with the fact that it was an online bank, Netbank, which means there were no tasty queues outside branches to photograph. It's probably also because it has been taken over by Dutch group ING, while Northern Rock remains as yet - unloved and unbought.

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The collapse was the biggest in 14 years, and was blamed on "poor underwriting standards" by US lending regulator, the Office of Thrift Supervision. In other words, the bank wasn't careful enough with who it was dishing money out to.

The group's demise is just another blow to confidence in the global financial system. It won't be the last. And when confidence in the financial system is shaky, there's one sure investment to buy into gold

Ambrose Evans-Pritchard reports on a new gold report out from Citigate in this morning's Telegraph. The authors, John Hill and Graham Wark, say that they reckon that central bankers of the world will do anything they can to try to avoid a global recession.

Being central bankers of course, that means slashing interest rates. And good old helicopter' Ben Bernanke (so-called because of his half-joking statement, made years ago, that the US could always drop dollars out of helicopters to encourage spending and avoid a repeat of the Great Depression) has already set the wheels in motion, by hacking the US base rate down by a full half-point.

Hill and Wark reckon this "massive, extended 'Reflationary Rescue'", involving "competitive currency devaluations could take gold to $1,000 an ounce, or higher."

As Evans-Pritchard points out, the dollar's collapse is all very well - but which currency is it going to be allowed to collapse against? Most of Asia relies to a significant extent on exports to the US, so they have no desire for a strong currency. In Britain, we have much the same problems as the US, so a jump into sterling from the dollar is a case of frying pans and fires, many would say.

As for the euro, as Evans-Pritchard says, the worse the post-property bubble collapses in Ireland and Spain become, the more obvious it will be that the Eurozone members have conflicting needs. There's already agitation for more political interference in the interest rate decisions of the European Central Bank, lead by French president Nicolas Sarkozy.

In the absence of a reliable paper money to take up the baton of world reserve currency, the prospects for gold only look better and better. And it seems central banks know it - central bank bullion sales earlier this year were "clearly timed to cap the gold price" reckon Hill and Wark. That's the kind of conspiracy theory chatter that has had gold 'bugs' of all stripes condemned as unhinged for years - and yet now it's coming from a major investment bank.

Why would central banks fear a strong gold price? It's simple. The gold price is essentially an indicator of confidence in paper money. The higher it is, the less confident people feel about the worth of their fiat currency. And if people lose faith in paper money, then effectively, they're losing faith in our entire economic system. When you think about it like that, you start to see why central banks might want to keep a lid on the bullion price.

Anyone who remains sceptical should understand that central banks are well aware of gold's power. They might dismiss it as a barbarous relic, but Alan Greenspan, the uber-banker and the man who, arguably, created the current situation (see our recent cover story on who's to blame for the credit crunch for more: Northern Rock - who's to blame?), has spoke of being a fan of gold many, many times. In fact, he reckons it's a good investment right now, as we enter what he likes to call "The Age of Turbulence".

Mischievous ex-central bankers aside, we also reckon that gold still looks good. It's headed up sharply recently, but with the credit crunch only set to get worse, the long-term outlook for gold is sound. You can buy physical bullion, or there are a myriad of ways to get non-physical exposure - see the gold section on our website for more details: Investing in gold.

And if you've got the stomach for a bit more volatility, then Citigroup reckons gold mining shares are overdue a strong catch-up with the gold price, which also seems a decent enough play. We've got more on gold mining stocks in this week's issue of MoneyWeek, out on Friday. If you're not already a subscriber, you can sign up for a three-week free trial by clicking here: Sign up for a three-week free trial of MoneyWeek.

Turning to the wider markets

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In London, the FTSE ended the day down 19 points, at 6,466, although a late rally saw the blue-chips pull back from an intra-day low of 6,411. Sugar stock Tate & Lyle tumbled by over 27% after it issued a profit warning. Miners Lonmin, Rio Tinto and Xstrata all gained on rising commodities prices. For a full market report, see: London market close

On the Continent, the Paris CAC-40 was down 17 points, at 5,715. And the Frankfurt DAX-30 was up 7 points, at 7,861.

On Wall Street, investor uncertainty over the latest tranche of economic data saw stocks close slightly lower on Friday, but the major indices were up on the month as a whole. The Dow Jones was down 17 points, at 13,895. The tech-heavy Nasdaq was off 8 points, at 2,701. And the broader S&P 500 was 4 points lower, at 1,526.

In Asia, the Japanese Nikkei made up earlier losses to end the day at 16,845 - a 60-point gain. And in Hong Kong, the Hang Seng was up 77 points, at 27,142, at time of writing.

Crude oil had risen to $81.88 this morning, and Brent spot was at $79.76 in London.

Spot gold hit a 27-year high of $746.30 today before falling back to $745.20. And silver had risen to $13.81, up from $13.71 in New York late on Friday.

In the forex markets, the pound was at 2.0440 against the dollar and 1.4369 against the Japanese yen. And the dollar was at 0.7028 against the euro and 115.48 against the Japanese yen.

And in London this morning, Northern Rock shares had tumbled by over 17% in early trading on speculation that bank may be sold at a discount.

And our recommended article for today...

Why the rising oil price could be bad news for the dollar

- Soaring equities, oil heading towards $100 a barrel and a plunging dollar all make for a very complicated picture. And an announcement by the Saudi Arabian central bank has just made it even more complex. For Jeremy Batstone-Carr's in-depth look at the implications of the ever-rising price of crude, click here: Why the rising oil price could be bad news for the dollar

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.