SO GOLD is now at “fair value” says Bill Bonner, long-time gold bug and my former boss/partner-in-crime at The Daily Reckoning’s London HQ.

No, he won’t sell yet…if ever…says Bill. But gold’s huge under-pricing a decade ago has clearly passed by. Value-hungry investors got their “reversion to the mean”, and in the form of 400% gains, too. What one ounce of gold bought 2,000 years ago – a good suit of clothes, in Bill’s oft-repeated example – it now matches, if not exceeds in price, here in late 2010.

From here, that makes it a “speculation”.

Never mind that, around the birth of Christ, all clothes were hand-cut and sewn locally…rather than glued together by the world’s cheapest labor, four or eight thousand miles away. A suitable outfit for visiting the coliseum or agora would have been made-to-measure, too…and today’s finest tailors, at least in London or New York, will ask much more than the $1240 you’d raise by selling one ounce at current “spot gold” prices.

Never mind all that. Because Bill’s point is well made, again…

Gold was a screaming buy at the start of last decade, sinking to its lowest price – in real terms – since the early ’70s, as the chart above shows (courtesy of the World Gold Council, and taken from Roy Jastram’s incomparable study, The Golden Constant).

But “Nobody cared! Nobody was interested,” as a (very drunken) London dealer cried at me late last year. “I’d email out jokes, porn-site links, anything to get clients reading so I could repeat three simple words: ‘Buy gold now!’

“But they didn’t care…I don’t even know if they looked at the porn…”

Today, in contrast, you can’t move for anxious investors and bullish hedge funds piling into gold. Or so the media coverage would make it seem. New gold dealers – online and on Wall Street – are meantime sprouting like fungus to catch the “retail dollar”, and the story’s grown so old, it’s even spawned its own calendar for financial hacks (the summer lull, India’s post-harvest festivals, quarterly data from the mining-backed World Gold Council, the Sept-end of each year of the Central Bank Gold Agreement). Wherever you look, the only debate that counts – “It must be a bubble, so when will it burst?” – rolls on for what is now more than two years.

As for the dumb lump of metal, yes – it continues to pull in new money, nudging its purchasing power ever-closer to the big top of 1980. But look again at that chart above. For while Roy Jastram saw a “golden constant” in his two centuries of US data (and four centuries of British gold prices), the shorter-term volatility is striking. Not least since gold ceased being money 39 years ago, and became mere trinkets and collectibles instead.

“In terms of what gold will buy, it does not seem undervalued to us,” Bill Bonner writes. “As near as we can tell, gold is now fairly priced.

“[So] the reward now is different. It is speculative…not inherent. We cannot expect to make money by waiting for the metal to revert to the mean. It’s already at the mean.”

But what is gold’s mean purchasing power – the “golden constant” of Jastram’s peerless research? By our reckoning here at BullionVault today, it has risen sharply since the US abandoned its last pretence of a gold standard and floated the Dollar in August 1971. Compared with the first seven decades of the 20th century, in fact, gold’s real purchasing power has stood more than 75% higher on average. Which seems odd. Because without being used as money – its only utility beyond decoration – gold became only more valuable. So while its purchasing power may have looked “constant” across long historical periods from Roy Jastram’s vantage of 1977 (and again to die-hard gold bugs 20 years later), its utility had in fact changed.

Gold became more useful as a way of storing purchasing power, even though it was no longer money. Or rather, because it was no longer money, in an age where “Every morning, when you look in the mirror, I want you to think ‘What am I going to do today to increase the money supply?’…” as John Ehrlichman, assistant to Richard Nixon, apparently told Fed governor Charles Pardee, sometime in the early 1970s. Post-war economic policy across the West was haunted by the Great Depression, and thus flowed from the fear that, unless money was losing value, then spending and particularly investment growth would grind to a halt.

Without the spur of inflation, capital would choose to sit tight – in purses, pockets and deposit accounts – because its purchasing power today would be retained tomorrow. Savers could thus spend (or not) as they chose, rather than being forced to exchange or grow their money to realize or maintain its present value. Devaluing their money, in contrast, via persistent (and obvious) inflation would force savers into the stores and stock-broker’s office. And thus today’s targets for persistent (and obvious) inflation were born.

“[Harvard professor] Kenneth Rogoff is proposing that the United States use a burst of inflation to get out of its slump,” writes Princeton professor Paul Krugman. “I agree…[but] if central banks can gain any leverage at all, it’s only by credibly committing to inflation over a fairly sustained period…[not Rogoff's] two or three years of slightly elevated inflation.”

Bill Bonner’s bang on the money, in short. Gold from here is a speculation, but a speculation only on academics getting their inside man (whether Mervyn King in London or Ben Bernanke in Washington) to apply their latest hare-brained scheme – massive new money inflation.

What price gold’s utility as a store of real value if…when…they succeed?

Adrian Ash

For Money Morning Australia

Adrian Ash is head of research at www.BullionVault.com

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

WHATEVER the reasons for China’s massive household savings rate (Western economists blame the lack of social security, so you can guess their cure), the World Gold Council’s Gold Demand Trends today showed private consumers putting ever-more money into physical gold.

Compared to household savings, in fact, revised forecasts here at BullionVault this morning put likely gold purchases in 2010 at the equivalent of almost 1.7% – over twice the level of five years ago.

This confounds Western analysts who foresaw substitution – from gold jewelry to consumer gadgets – as China’s household wealth grew. Because gold demand, even for the kitschest gold kitten, remains an expression of saving, not spending.

That might jar with Western tastes and ideas. But it’s clear in the numbers.

According to Peking professor Michael Pettis – and despite disposable income growth of perhaps 15% annually since 2000 – consumption growth in the world’s No.2 (and fastest-growing) economy “is anemic” by comparison. A BIS study last month suggested it’s because household earnings are falling as a proportion of national income. But either way, and in contrast with consumption spending, private Chinese gold demand has risen 26% annually by volume in the last decade, drawing a still-greater share of retained wealth as domestic gold prices rose near three-fold.

So where Western analysts divide “jewelry” from “investment” demand, Chinese gold buying – as in India, the world’s No.1 market (for now) – cannot be so easily split. Gold’s form doesn’t define its purpose so tightly in China, as North American and European gold sellers have rediscovered since the financial crisis began.

Swapping gold-for-cash by ditching unwanted jewelry, the Western world’s new “scrap gold” sources are simply finding in gold a value they’d forgotten was there. Stored wealth in whatever shape is still wealth. The trick, of course – and as China’s fast-growing “investment products” demand now shows – lies in reducing your transaction costs both on purchase and sale.

Adrian Ash
For Money Morning Australia

Adrian Ash is head of research at www.BullionVault.com

THE PRICE OF GOLD rose to its best level since the start of July in early trading on Monday, rising above $1226 per ounce as world stock markets sagged but commodity prices ticked higher.

Crude oil bounced from a 1-month low, and wheat futures rose again after dipping from this month’s near-two year high – sparked by Russia banning exports amid its worst drought in five decades.

Silver prices edged up to $18.30 an ounce, some 2.6% above last Thursday’s two-week low. So-called “safe haven” government bonds also rose following weak Japanese GDP data, nudging the 30-year US Treasury yield down to a 16-month low of 3.80%.

“The low [in gold] turned out to be at $1156 per oz,” says a review of this summer’s action so far from Canada-based bullion bank Scotia Mocatta, “which was just a few dollars below the up trend line” starting after the collapse of Lehman Bros in late 2008.

“The reasons for the correction in price were numerous, but the theme was generally the same,” says Scotia – “a shift in investors’ sentiment from being less risk averse to having more risk appetite

“This in turn saw safe-haven assets retreat.”

“Longer-term, the problems that lead to the gold rush of earlier this year have not been eliminated,” says Wolfgang Wrzesniok-Rossbach, head of sales at German refining group Heraeus, who cites “exorbitant” government deficits in Europe, continued mortgage-debt problem in the US, concerns over China’s growth, and the level of “hidden inflation” in official figures worldwide.

Noting the 15% drop in Euro gold prices from June’s record high of €33,800 per kilo however, “In the past few weeks investor interest in middle Europe more or less came to a standstill,” Wrzesniok-Rossbach says, calling it “noteworthy” that gold coins – mainly Krugerrands in Germany – “were being sent in for melting by dealers.”

Back in Monday’s action, “Risk aversion is likely to keep an underlying bid in place for gold,” says a note from Barclays Capital, quoted by Reuters.

“Short term, $1215 has [marked a] series of market highs since early July, so we would regard a move through this level as a bullish breakout. We expect this to occur, especially with gold approaching a strong seasonal period.”

Latest data from US regulator the Commodity Futures Trading Commission showed a 4% bounce last week from mid-July’s five-month low in the “net long” position held by hedge funds, private investors and other speculative players in gold futures and options.

Rising to the equivalent of 775 tonnes, however, speculative bullishness remains one-quarter down on the record level of October ‘09.

Over on the other side of the market, bearishness amongst traders acting for miners, refiners and bullion banks – sometimes known as the “smart money” – last week ticked higher again from late July’s 19-month low, with short positions now rising from just 30% to 35% of the commercial sector’s directional bets, right in line with their 5-year average.

“Following the sharp decline in long [speculative] positions, we believe that the recent stabilization in the net long position may signal room for new longs to be added,” says Standard Bank’s Walter de Wet in a note today.

“We maintain that gold will reach $1300 in Q4:10.”

The Japanese Yen meantime rose further on the forex market early on Monday, ticking back towards last week’s attempt at a 15-year high versus the US Dollar, which also slipped against most other major world currencies.

The Chinese Yuan, however, dropped to a 7-week low against the Dollar, after the People’s Bank of China set its official exchange rate above CNY 6.80 for the third session running.

“The race for the bottom continues,” says Steven Barrow, de Wet’s colleague and chief currency strategist at Standard Bank in London.

Following “the deterioration in US economic data in June and July…things have [again] started to look bad for the Euro,” says Barrow.

New data today showed China overtaking Japan as the world’s second-largest economy, but “It’s clear Beijing doesn’t want to see appreciation [in the Yuan exchange rate] bring more troubles” to its export-dependent economy, as a local economist at Citigroup put it last week.

China’s vice-minister for commerce, Zhong Shan, writes in the official Seeking Truth magazine today that Beijing must “keep the Yuan basically stable” to support its exports, which rose more than 38% in July from the same month last year.

The gold price in Chinese Yuan rose to a 7-week high this morning, while the Shanghai stock market rose 2.1% but held more than one-fifth down for 2010 to date.

Eurozone and UK investors looking to buy gold today meantime saw the price rise to its strongest level in a month, edging 0.4% higher even as the Euro and Sterling rose vs. the Dollar to touch €30,790 per kilo and £785 per ounce respectively.

Adrian Ash
BullionVault

Adrian Ash is head of research at www.BullionVault.com

Economists / forecasters / tea-leaf-readers had been expecting a net loss of 55,000 odd jobs. The actual figure came in at more like 131,000 jobs lost.

The fine print contained more bad news, including a big fall in part time workers. This is normally a prelude to full time jobs being axed.

Where does this leave the US?

Take a minute to look at the excellent chart below from Calculated Risk. The red line skulking around at the bottom of the chart shows what proportion of the work force have lost their jobs so far during the current recession. For comparison, the other lines show what happened during all the other post-war recessions.

You can see we are 31 months in so far. The red line shows us that we are looking at a real possibility of the insipid employment recovery stalling already, and the job numbers getting even worse.

Click here to enlarge

Dire news indeed: The S&P500 answered by falling 1.6% in half an hour.

The strange thing is that the markets then bounced sharply to make most of the ground back, closing down by just 0.2%. What is going on?

The reason for this counter-intuitive response is that the markets are now sure that the Fed will now have to pull out the stimulus measures again. What, because it worked so well the first time?

On Tuesday night the Fed issues its monetary policy statement, so we find out for sure soon. It seems more than likely the printing presses will be turned back on again.

This is bad news for the US dollar. But this is good news for the markets – hence the bounce.

It’s also good news for precious metals prices. Platinum was up by 0.1%, Silver was up 0.8%, and gold was up 0.9% immediately after the news. As editor of Diggers and Drillers, more than half of my current recommendations are on precious metals.

At the end of last month, in Diggers and Drillers I argued the case that the falling gold price would be short lived, and that we would be looking at a new high for the gold price by September. My advice was to make gains by getting onto our gold stocks whilst prices were temporarily depressed.

D&D readers that took this advice will have made up to 18.4% in a week, with the average across our four current gold stocks being 13.04%. Not bad for a week.

The good news for those that missed it is that this should just be the beginning. I still reckon gold will be hitting a new high before too long, taking good gold stocks up with it. My view comes down to the one sided balance in the gold market: supply can’t keep up with demand. This normally increases around this time of year as seasonal factors increase demand further. Now the Fed is putting the taps on again, expect the gold price rise to accelerate further.

Below is an extract from the Diggers and Drillers 30 July weekly update, where I made my case for a bounce in the gold price.

Gold and gold stocks on the cheap until September

Click here to enlarge

My point is that a bit of perspective is called for by the sensationalist media.

I’ve compiled the chart below from institutional data showing the average monthly price change in the US dollar gold price since 2005. I’ve made the chart show the cumulative monthly gain, so that the red line shows the net effect over the course of the year. The blue line shows the trend. It is well known that July and August is normally a lousy time of year for gold. Gold’s run typically kicks off in September, and has finished the year up 9.21% on average for the last five years. This is all down to which markets are buying and when. Stocking up for the Indian wedding season, and Chinese New Year are big factors for example. Last year was a perfect example.

These short-term dips are great buying opportunities for anyone that appreciates the underlying supply – demand fundamentals. The supply picture is outlined nicely by the chart below. Mining supply (navy blue in the chat below) is slowly falling, despite pouring money into exploration. The easy gold has mostly been mined and an increase in production is looking highly unlikely. Scrap supply (light blue) has been tapped up a fair bit in the last few years and is now decreasing. To top it off, official sector sales (central banks – in red), has ceased. In fact, central banks overall are now buyers of gold. You wonder if, just perhaps, they know something.

Total global supply seems to be capped at 4,000 tonnes a year, despite rising prices and rising demand. What the media hasn’t woken up to on the demand side of the picture is the explosion underway in Chinese gold demand. The government has made intentional changes to increase gold investment by the general public. This waking dragon is the one single factor that has the scope to tip the gold market into deficit in no time at all. A quick look at the volumes of physical gold traded on the Shanghai Gold Exchange you can see how fast this market is growing.

The bottom line is this: Supply is tight, demand is rising, so the gold price will rise.

The price rise will be volatile, and may possibly even pull back further in August first. But when the gold price sets new highs again in September or October, expect to see the frenzied media quoting the gold bulls once more like long-lost friends.

Until then, there is going to be some good buying in gold and gold stocks.

Dr Alex Cowie
Diggers and Drillers
For Money Morning Australia

WHATEVER FORCE you spy behind this week’s swoon in gold prices to $1160 per ounce and lower, ’tis but a scratch – a flesh wound – so far.

“I’ve had worse!” as Monty Python’s Black Knight says.

First, the current options contract on gold futures expired Wednesday, guaranteeing volatility. Because as bullish speculators moved to close and rollover their position in the derivatives market, those banks taking the other side of the trade were only too happy to oblige.

Call that manipulation if you must (double-check your facts first), but more broadly, long-time investors and traders would always expect to see a seasonal lull – if not drop – in gold prices between July and Sept. India’s gold-hungry millions don’t buy over the summer, waiting instead until autumn’s post-harvest Diwali festival. And after the huge gains spurred by the Greek crisis of April and May, a pullback in gold investment pressure looked due.

Of course, that’s not to say the gold bull-market starting a decade ago hasn’t just met its end. Some in the finance media would like to believe it’s over (even if, like this article at the Sydney Morning Herald, they seem more driven by resentment than analysis). But for now, recent history says the bull market in gold is a long way from losing both arms and legs just yet…

Dropping a little over 9% from last month’s top to date, the gold price in Dollars would have to reach $1073 an ounce before matching the 15% drops of Dec ‘09-Jan ‘10 and Feb-Apr ‘09.

Gold would need to hit $948 an ounce before matching the 25% drop of May-Jun ‘06. And it would have to reach $834 before matching the 33% Mar-Sept. loss of 2008.

This current swoon is also a good way from setting new records for pace, too. Top to bottom, it’s nothing – so far – next to the 16% week-on-week drops of June 2006 and Sept. 2008.

Western government deficits are set to keep rising, meantime, while real interest rates remain below zero everywhere, slowly destroying the value of cash. Gold, in contrast, continues to find favor with central-bank reserve managers, and private Chinese gold demand is undimmed.

Indeed, “with all the deregulation we’ve seen in China and the Chinese gold market being so alive, it may just turn out to become a bit of a casino atmosphere over there,” says gold-mining magnate Pierre Lassonde, speaking to MineWeb – “a gambling atmosphere [that] could very well push the gold price beyond anything that we believe is reasonable.”

Small comfort to investors or traders picking early July’s dip as a bargain, perhaps. But so far, it’s only a scratch. And whatever nemesis gold has stumbled across in July, it’s certainly got nothing to do with the long-term drivers of its four-fold gains to date.

Adrian Ash
for Money Morning Australia

Adrian Ash is head of research at www.BullionVault.com

GOOD JOB that gold bullion is just an inert lump of metal and holds no grudges.

Because twice in the last decade, the value of gold in the Swiss National Bank’s vaults has nearly halved as a proportion of its total reserves. Yet still it sits there, helping save the SNB’s blushes when policy fails.

“The Euro-crisis has torn a deep hole in the calculations of the Swiss central bank (SNB),” reports Tages Anzeiger. “It spent CHF 104.9 billion on Euros [US$104bn] in the first-half of 2010, leading to foreign exchange losses of over CHF14bn [$13.3bn].

“Bottom-line losses were reduced to CHF4bn however [$3.8bn] by gains on other foreign currencies like the Japanese Yen, plus the strong rise of the gold price, which revalued the gold reserves of the central bank.”

Long before gold hit last month’s record above CHF 46,600 per kilo, gold’s first plunge as a proportion of Swiss reserves was very deliberate and clearly flagged.

Gold bullion sales totaling 1300 tonnes between 2000 and 2005 coincided with a gentle rise in total reserves, slashing the metal’s weighting from 44% to below one quarter. Not coincidentally coinciding with the launch of the Euro – bureaucracy’s greatest monetary hubris to date – the Bank wanted to reduce its huge gold allocation, and buy apparently more useful, more valuable things instead.

The surge in the gold price starting in the middle of last decade soon put paid to that, however. And so the second plunge in gold’s weighting, in contrast, has come thanks to a trebling of the SNB’s total reserves, driven in no small part by its print-Francs-to-buy-Euros policy, aimed at keeping Swiss exports competitive.

But again, no dice! The Swiss Franc has risen vs. the Euro regardless of the SNB’s huge money creation, gaining 12% against the single currency since quantitative easing began at the start of 2009. And gold still accounts for almost one quarter of Switzerland’s central-bank reserves, now massively swollen to US$162bn.

Not that gold enjoys such jokes or historical irony, you understand. It is simply a lump of rare, indestructible metal, after all.

Adrian Ash
For Money Morning Australia

Adrian Ash is head of research at www.BullionVault.com

DID YOU HEAR about the giant gold coin auctioned in Austria late last month?

Of course you did – courtesy of Bloomberg if not CBS, the Daily Mail, BBC, BusinessWeek, USAToday, France24, Vancouver Sun, Wall Street Journal, Financial Times, Daily Telegraph, San Fran’ Chronicle, Khaleej Times or The Australian…

You could hardly kick the cat for tripping over this story. Which is more than can be said for bidders missing the auction. Not even the final buyer turned up. Madrid’s Oro Direct sent a written bid instead.

“There were no counter offers,” as Reuters confessed, “in an auction room packed with more journalists than potential buyers.”

Still, it made good copy. Or it would have, had the story gone to plan. Because the 100-kilo gold coin – one of only five $1m Canadian Maple Leafs ever produced by the Royal Canadian Mint – sold for just melt value (€3.27m), rather than the 28% premium touted to the financial pages by the auctioneer’s advisors.

But hey, let’s ignore the facts. Just feel the frenzy! There’s a crazy gold rush going on. Everyone agrees! Or at least, everyone in the financial media. Finance.Yahoo now quotes gold futures prices in its Market Summary box on the homepage, right alongside New York’s big stock indices, crude oil contracts, and 10-year Treasury-bond yields. Reuters’ homepage also features gold investment news whenever it can, putting news of a $2 rally in wholesale prices second only on Tuesday morning to the Nikkei hitting 7-month lows, and ahead of crude oil’s drop to 4-week lows “on economic pessimism.”

So never mind that Reuters’ gold piece didn’t feature in the top 10 either shared or viewed stories. No matter that – up there at the top – “Jessica Simpson” continued trending on Yahoo searches, as did Lindsay Lohan, with Bruce Willis and his new cologne now hot on her heels, and Orlando Bloom’s Hugo Boss contract not far behind.

See, humanity isn’t fixated on celebrity, oh no. It’s been filling its boots with gold bars and coins instead…a sure sign of global financial panic and a clanging bell that the top must be in.

Gold is over-owned, not over-reported. Saturation is here! Those guys shouting “Bubble!” at the Wall Street Journal and the Sydney Morning Herald…they’re smart contrarians, not jobbing hacks simply pitching for this year’s “Phil Space” award. Oh sure, they didn’t call gold when it hit 20-year lows a decade ago. But they can spot a bubble when they see one. Right?

“Gold investment is very visible, but expression is low,” said John Levin, HSBC’s head precious metals trader in London, at the FT’s Silver Conference in the City last month.

On a show of hands from the audience – some 100-odd delegates – less than half owned or were invested in precious metals. And that was amongst the most qualified sample of the world’s population you could wish for…an institutional precious metals conference in the City of London, heart of the world’s professional bullion market.

“We’re only now seeing big money accounts,” he said, “true investment…portfolio allocations seeking gold and silver in a secure location, where they can just put it to bed.”

“We’re almost at the beginning of the real run,” Levin added, inviting delegates to ask their friends, family and acquaintances just how much gold and silver they’d rushed into lately when next they met.

Put down your iPad, newspaper or TV remote, and go do the same perhaps.

Adrian Ash
For Money Morning Australia

Adrian Ash is head of research at www.BullionVault.com

But hang on. The average property price has increased three or four time in the past ten years. Yet for ‘fundamental reasons,’ he doesn’t believe that there’s a property bubble.

In his report, Robertson suggests that most gold buyers purchase the ‘pretty rock’ as a hedge against inflation. Yet, he doesn’t believe that there are signs of inflation right now.

But that’s the interesting thing about inflation. You don’t need ’signs’ of inflation to feel the effects of inflation. All you know is your five dollars you used today is buying you less than what your five dollars bought you last week. And if your purchasing power is less than it was yesterday, that’s inflation at work.

Putting gold as an asset and a hedge against inflation aside for the moment, for the past few months other factors have been driving the price of gold. One of those factors is fear.

In recent months you could only use the words ‘financial turmoil’ to describe the current global financial system. For years, economies have been running on massive debt levels made possible by government-controlled fiat currencies. If the past few months are anything to go by, paper money is losing the confidence of the investing public.

Countries like Greece, Spain, Italy and Portugal are directly in the spotlight. They’ve been forced to confront unsustainable fiscal and monetary policies and deal with large sovereign debt levels. At least they are dealing with it-although no one is sure if ‘austerity’ will work or if default is just a matter of time.

But what about countries who haven’t even admitted they have a debt problem? There is some serious fiscal denial in certain parts of the world. America is serious financial trouble. But the U.S. Congress hasn’t even passed a budget for this fiscal year. The government keeps on spending money it doesn’t have by borrowing money it may never be able to repay.

Traders are onto this. While the U.S. has not yet been put on watch by the credit ratings agencies and can’t, in theory, directly default when the Fed has the power to print money, investors are no longer treating US dollars as a safe haven, reserve currency asset. In fact, people are dumping their greenbacks and replacing them with gold bullion. It’s well known that China and India have been increasing their gold bullion stores, rather than hold risky US dollars.

All of these factors combined had driven more investors to gold. Which is exactly the reason Robertson thinks the metal is in a bubble. He believes that the more people that buy something simply because it always goes up - hasn’t this argument been used for property? - is the very stuff of bubbles.

But there’s more to gold than that. Aside from it being pretty, it has a real use.

It’s safe. It’s real and you can touch it. And in the worst ‘end of the world’ situation, you can take a small shaving from your gold bar down to Coles and buy your groceries if paper money falls over. People have been using gold as money for thousands of years. They call small units of gold used for every day transactions-get this-coins! Yep, a real revolution!

OK, that might be a little dramatic. But no more dramatic than Robertson saying ‘…anticipating extraordinary financial and societal turmoil down the track, gold fits into a portfolio rather nicely alongside automatic rifles, cases of ammo and beans and hilltop bunkers.’

While we’re not suggesting you start stock piling guns and beans next to you bullion stash, the financial system collapsing isn’t such a farfetched option. In fact, I can’t think of any time in history where a fiat currency system hasn’t crashed.

Or so says Macquarie Group interest-rate analyst Rory Robertson. You might remember Mr. Robertson as the man on the other side of the bet about Australian house prices with economist Dr. Steve Keen. Robertson won that bet and the good doctor dutifully trudged his way to the top of Mt. Kosciuszko.

It’s a pretty brave man that takes on the faithful gold bugs.

Let’s be honest, the past ten years have seen gold enjoy a pretty nice bull run.

But does that mean that the price of gold is in a bubble?

In fact, as Robertson wrote in his ‘Bubble Watch’ report for his clients, the price of gold is five times higher today than it was ten years ago.

But hang on. The average property price has increased three or four time in the past ten years. Yet for ‘fundamental reasons,’ he doesn’t believe that there’s a property bubble.

In his report, Robertson suggests that most gold buyers purchase the ‘pretty rock’ as a hedge against inflation. Yet, he doesn’t believe that there are signs of inflation right now.

But that’s the interesting thing about inflation. You don’t need ’signs’ of inflation to feel the effects of inflation. All you know is your five dollars you used today is buying you less than what your five dollars bought you last week. And if your purchasing power is less than it was yesterday, that’s inflation at work.

Putting gold as an asset and a hedge against inflation aside for the moment, for the past few months other factors have been driving the price of gold. One of those factors is fear.

In recent months you could only use the words ‘financial turmoil’ to describe the current global financial system. For years, economies have been running on massive debt levels made possible by government-controlled fiat currencies. If the past few months are anything to go by, paper money is losing the confidence of the investing public.

Countries like Greece, Spain, Italy and Portugal are directly in the spotlight. They’ve been forced to confront unsustainable fiscal and monetary policies and deal with large sovereign debt levels. At least they are dealing with it-although no one is sure if ‘austerity’ will work or if default is just a matter of time.

But what about countries who haven’t even admitted they have a debt problem? There is some serious fiscal denial in certain parts of the world. America is serious financial trouble. But the U.S. Congress hasn’t even passed a budget for this fiscal year. The government keeps on spending money it doesn’t have by borrowing money it may never be able to repay.

Traders are onto this. While the U.S. has not yet been put on watch by the credit ratings agencies and can’t, in theory, directly default when the Fed has the power to print money, investors are no longer treating US dollars as a safe haven, reserve currency asset. In fact, people are dumping their greenbacks and replacing them with gold bullion. It’s well known that China and India have been increasing their gold bullion stores, rather than hold risky US dollars.

All of these factors combined had driven more investors to gold. Which is exactly the reason Robertson thinks the metal is in a bubble. He believes that the more people that buy something simply because it always goes up – hasn’t this argument been used for property? – is the very stuff of bubbles.

But there’s more to gold than that. Aside from it being pretty, it has a real use.

It’s safe. It’s real and you can touch it. And in the worst ‘end of the world’ situation, you can take a small shaving from your gold bar down to Coles and buy your groceries if paper money falls over. People have been using gold as money for thousands of years. They call small units of gold used for every day transactions-get this-coins! Yep, a real revolution!

OK, that might be a little dramatic. But no more dramatic than Robertson saying ‘…anticipating extraordinary financial and societal turmoil down the track, gold fits into a portfolio rather nicely alongside automatic rifles, cases of ammo and beans and hilltop bunkers.’

While we’re not suggesting you start stock piling guns and beans next to you bullion stash, the financial system collapsing isn’t such a farfetched option. In fact, I can’t think of any time in history where a fiat currency system hasn’t crashed.

Shae.

HOW HAS GOLD reached and breached new all-time highs in the absence of strong 1970s-style inflation?

The Buttonwood column in last weekend’s Economist is only the latest analysis to miss the point, and despite tripping right over it, too.

“Owning gold is traditionally seen as offering protection against inflation. And inflation is very bad news for owners of government bonds.

“But the ten-year Treasury bond yields just 3.3%, a level that is towards the low end of the historical range…You would expect the performance of gold and Treasury bonds to be inversely correlated. When gold was at its real all-time high in 1980, the ten-year Treasury-bond yield was 10.8%. Fixed-income investors had suffered years of negative real returns in the 1970s.”

But there’s the rub, as we never tire of telling people here at BullionVault. They tire so quickly of hearing it, however, that even The Economist can’t square the circle of rising gold, falling bond yields. Because it never was inflation alone in the ’70s that drove people to buy or sell a lump of rare, indestructible metal. It was rather the rate of return offered by cash and bonds – those better competitors as a store of wealth, all things being equal – over and above (or below) inflation.

That’s why gold made a terrible inflation hedge in the 1980s and ’90s, most especially for Dollar investors. Because no-one needed an inflation hedge! Not when 10-year Treasuries paid 4.3% on average over and above CPI inflation. Not when the real Fed Funds rate averaged 3%-plus…leaving gold to drop three-quarters of its real Dollar value inside 20 years…as the real value of cash-on-deposit doubled.

Now compare and contrast with the last eight-and-a-half years. CPI inflation has averaged barely half its previous two-decade average, yet the real returns paid to bonds and cash have collapsed. Adjusted for inflation, in fact, the real Fed Funds rate has now been below zero for 54 of the last 101 months. That matches the 54 months of sub-zero real rates which the Fed delivered in the 1970s…

…but things are worse yet, of course. First because that decade’s 54 months of negative real rates were spread across 10 full years from Jan. 1970. So second, the overall effect on the average real rate since 2002 has been to drive it lower again.

Short of a revolution in Fed thinking (no sign of that today), the decade starting Jan. 2002 looks set to deliver yet more negative real rates before 2012, if not beyond. Which will continue to mean that:

• Holding cash-on-deposit guarantees a loss of real value, something that even the most passive, cautious savers will only put up with for so long;

• The opportunity cost of holding gold or silver – the foregone interest you’d otherwise receive on cash – remains absent.

The monetary metals may not have been official money for many decades today. But the Fed’s interest-rate policy is actively leading the remonetization of gold and silver as popular stores of value.

Because when “risk free” cash keeps paying a guaranteed loss, then a growing number of people will, in due course, start seeking shelter elsewhere. At the same time, holding gold and/or silver has ceased being a burden (bullion storage rates need not be onerous), inviting fresh flows of retained capital, tired of earning nothing or less.

Real returns to cash have now been low-to-negative for almost a decade, and so it might not be too long before a far broader, and thus larger, volume of savings turns from cash to the obvious and historic alternatives. Either that or the Fed will hike rates so high, you get 4% and more above inflation.

Adrian Ash
for Money Morning Australia

Adrian Ash is head of research at www.BullionVault.com