Gold's value likely to see a familiar anticlimax

December 11, 2005|By JAY HANCOCK

Three years ago, when an ounce of gold cost $312, I pooh-poohed the idea of owning it.

"I agree that gold looks better than a Treasury bond on a wrist or a bosom, but as a long-term investment it doesn't seem more attractive than it did a decade ago," I wrote. And: "For the long haul, I'll take a few shares of [Eli] Lilly or any attractive U.S. company over a high-class rock."

Since then, gold has risen 70 percent. A Treasury bond has delivered 30 percent. And Lilly stock has returned negative 13 percent, even if you count dividends.

Serve up the baked crow, baby, on a 24-carat platter. At $530 or so an ounce, gold has reached its highest level since the early 1980s, when Fortune quoted Utah investment guru/survivalist Howard Ruff as saying the yellow stuff could hit $2,000.

But I'm not ready to put on a bib and dig in.

The three years since the column ran is not "the long haul" I mentioned. A long haul is a decade or more. Whatever its symbolic allure or short-term trading opportunities, gold offers no better stake in the growing global economy now than it did in 2002. And the arguments for even higher gold prices sound a lot like ones from the early 1980s, just before gold turned to dross for two decades.

Middle East turmoil and soaring oil prices are launching petrodollars seeking safe haven into gold, say the gold bulls. The Federal Reserve has lost control of the money supply. Inflation and deficits have tarnished the dollar as the world's store of value. And growth of the middle class in India and China will hugely increase demand for gold jewelry.

First, the petrodollar factor.

It is undoubtedly real, as it was 25 years ago. The Soviet Union's invasion of Afghanistan and the Islamist revolution in Iran had put Arab regimes on edge. A huge increase in oil prices gave them billions in assets to protect, and much of the stake bought gold.

(Oil transactions are done in dollars, so the money rattles around the world in greenbacks; hence, petrodollars.)

These days, new oil appreciation and new Middle East wealth - combined with perennial regional unrest and another war involving another superpower - have sent new petrodollars seeking a golden harbor.

Disrespect by gold fans for the dollar, the Federal Reserve and Washington's fiscal discipline also rhymes with that of the early 1980s. So does fear of inflation, which thanks to high oil prices promises to rise at its fastest rate this year since 1991.

"At current rates of inflation, the dollar price of an ounce of gold will push into the $5,000 to $10,000 range within a generation," economist Robert Mundell wrote in The New York Times in 1980.

He blamed inflation on "the breakdown of the gold standard and the lack of constraints on money creation by the Federal Reserve System, the greatest engine of inflation ever created by man."

Yesterday's gold bugs even trotted out the "soaring global jewelry demand" argument.

"With people in Third World countries beginning to demand the goods and services that we take for granted, the demand for both gold and silver will increase substantially during the near future," a gold salesman wrote in Industry Week in 1981.

That was right before gold, which hit $850 an ounce in early 1980, sank from $475 to $400, on its way to $285 by 1985. The case for gold looks even less plausible now than it did in 1980. Inflation, which hit 13.5 percent that year, was at least a real threat.

This year inflation will be lucky to breach 4 percent, and then only because of temporary spikes caused by Hurricane Katrina. In 1983, the federal deficit was a worrisome 6 percent of the gross domestic product; for fiscal 2005 it was less than half that.

Then, the dollar was shaky, U.S. unemployment was terrible and U.S. productivity growth was stagnant. These days unemployment is tame, productivity has been booming for a decade, and the dollar, which often falls against other currencies when gold rises, has been appreciating against the euro, yen and others.

And there doesn't seem to be a big leap in jewelry use, either. Figures from the World Gold Council show that gold jewelry demand in tons was about the same for the 12 months ending in September as it was in 1996. Third-quarter gold sales were driven largely by a huge increase in demand for "investment," largely in exchange-traded funds on Wall Street, the council says.

Gold bugs are right to worry about the Federal Reserve. The central bank's laxity has abetted unsustainable price spikes in Nasdaq stocks and housing. Now it has helped do the same for gold. But there is also no reason to think the fate of the latter will be much different than that of the former.

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