Gold making a currency comeback?

Leon Alberts

The idea that the world’s leading economies should consider adopting a modified global gold standard as part of a new dispensation for international currency rates, first mooted in November last year by World Bank president Robert Zoellick, could gain new traction in the wake of the recent debt ceiling crisis in the United States.

One of the consequences of the drama in the US Congress leading up to the last-minute lifting of the debt ceiling on 2 August, is that the dollar has lost its safe haven status.

For some time now, there has been a move away from the dollar as currency of last resort, as increasingly international economies and trade blocs decided to use their own currencies as means of payment in mutual trade.

Early in August, Bloomberg reported that the committee of bond dealers and investors that advises the US Treasury said the dollar’s status as the world’s reserve currency “appears to be slipping”. The committee added that the outperformance of haven currencies (such as the Swiss franc) and those from emerging nations has aided the debasement of the dollar’s reserve status.

“The idea of a reserve currency is that it is built on strength, not typically that it is best among poor choices”, it was stated in one of the presentations by a committee member. “The fact that there are no currently viable alternatives to the US dollar is a hollow victory, and perhaps portends a deteriorating fate.”

Markets weigh in for gold

Markets have de facto confirmed gold’s enduring status as reliable preserver of value – defying the predictions of many experts by increasing in price to even higher record levels after the last-minute deal to lift the US debt ceiling.

The other story that the gold price was telling, was that the markets did not believe the crisis in the US was over and/or that – with the latest dismal global manufacturing figures and a new crisis round in the European sovereign debt drama, and signs of the German economy slowing down, among others – the market does not believe there is an economic turnaround at hand.

Gold remains a neutral barometer of market expectation.

Zoellick’s suggestion

Zoellick (a former US trade representative who served in several Republican administrations, among others as a senior official in the US Treasury) in an article for the Financial Times called for a Bretton Woods II system of floating currencies as successor to the Bretton Woods fixed-exchange rate regime that broke down in the early 1970s. Since then, the US dollar has effectively been the global currency of final resort.

He wrote that this “is likely to need to involve the dollar, the euro, the yen, the pound and (a yuan) that moves towards internationalisation and then an open capital account.

“The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values.”

Zoellick’s suggestion was met by some surprise and even scepticism by analysts at the time, while the gold price was testing record levels of just under $1 400.

One reputable analyst, Mark Pervan, at the time said “the dollar is losing its relevance, especially with the emergence of Asian economies, so a more neutral benchmark may be required.

“Gold, amid all the uncertainty, is proving its worth.”

The extent to which gold has proven itself over the ages as a reliable preserve of value is borne out by data from the World Gold Council and precious metal dealer, Kitco, dating back to 1851.

Alex Dumortier of The Motley Fool website (www.fool.com), also in November last year, constructed a series of inflation-adjusted gold prices going back to 1851, according to which gold generated a historical average return of 0.7% per annum.

No big profit there – except for those who are in gold as speculators, who might have lost as well; but those who wanted to retain value over time could hardly have gone to a better destination.

Dumortier, however, along with plenty other analysts, was way off the mark with the short- to medium-term predictions for gold. He warned investors against paying more than $1 300 for the precious metal, under a heading that read: “Warning! Gold Could Drop Below $500”.

In January this year, Philip Klapwijk of Canada’s GFMS said that while the gold price, at close to $1 400/oz – which at that stage was “in the early stages of a bubble”, but with momentum still to the upside – will rise over 2011 and possibly breaching $1 600/oz “either late this year or early 2012”.

In March, JP Morgan’s metals strategist Michael Jansen, speaking from Toronto, forecasted an average gold price of $1 465/oz for the year and a year-end price of $1 500/oz.

He claimed there was a shift by wholesale investors out of gold and back into equities: “We see equities emerging from a multi-year funk and moving into a two- or three-year bull market. And that, obviously, reduces the need for a portfolio hedge like gold.

But then came first the battle in the eurozone to formulate and find consensus on a second bailout of Greece, followed by renewed debt problems in other southern European economies; then the American curveball and discouraging manufacturing and other economic data from almost all over the globe.

Only days after the deficit deal in the US Congress, investors were still flocking to safe haven assets, which included Swiss francs and particularly gold, which looked likely to breach the $1 700/oz barrier this year. At the same time, equities were slipping on most global markets.

Role of central banks

It is probably telling that, among others, the recent rise in the gold price was supported by central banks, which switched already last year from being net sellers to net buyers of the yellow metal.

“I really think we can see quite a lot more activity from central bankers in the next couple of years, particularly from those in gold-producing economies,” Jansen said.

He and others may in the longer run be proven right that gold is entering bubble territory, but note should be taken of a remark in late April this year by the chairperson of Barrick Gold Corporation, Peter Munk, who said that gold fundamentals are passé.

The traditional supply-and-demand fundamentals that have determined the gold price in previous decades no longer apply. Gold prices are being driven by investors looking for security, and looking to protect wealth, Munk said at the annual shareholders meeting of the world’s largest gold company.

For the first time, investment demand exceeded jewellery demand for gold in 2010, and some analysts have suggested this puts the market in a precarious position, as prices could fall sharply if investor demand growth slowed or reversed. But that does not seem to be on the cards in the near future.

“Gold today is no longer related to a normal economic cycle of supply and demand, jewellery and Indian wedding seasons. All those things are passé – forget about them,” said Munk.

Gold is being driven by a fundamental, global and growing “lack of confidence in the world and in everything they were brought up to believe in,” he added.

Gold’s future is assured because, ultimately, more and more people “every day, looking for security and looking to protect wealth, are driven to gold,” Munk noted.