Gold the "barbarous relic" is outpacing currencies

By Neil Behrmann

December, 2006:- John Maynard Keynes, the great economist, once dismissed gold as a 'barbarous relic'. Some relic! Despite decisions by Western central banks to dump gold on the market in the past two decades, gold is gleaming.

Conventional investment strategists describe gold as a commodity. That is only partly true. Although the bulk of gold produced each year is turned into into jewellery, it remains a monetary reserve of central banks and a store of value. Indeed, gold this year has been behaving increasingly like a currency for investors who fear depreciation of paper currencies.

Many analysts have concluded that the US dollar slide has been the main reason behind gold's sharp rise from its mid-September low of US$574 an ounce to current levels of around US$630. It has been a contributing factor as have geopolitical uncertainties from fears about the civil war in Iraq, worries about Iran and Lebanon, and the continuing concerns about Israel and Palestine.

Besides that unstable region, which controls most of the world's oil supplies, North Korea's nuclear tests and fears about Russian democracy and the nation's hold on the energy markets and elsewhere are encouraging investors to hedge into gold.

But the most interesting aspect of the current move into gold is that it is being used as a hedge against general uncertainty in the currency markets. Gold, as a store of value and effective currency, has risen by around 10 per cent against both the US dollar and yen since mid-September.

It has outperformed major currencies, rising by around 6 per cent against the euro, sterling and Swiss franc. It has also jumped against the Singapore dollar and other Asian currencies and has risen by around 7-9 per cent against the Indian rupee and Chinese yuan.

With trillions of dollars washing around the world's money and capital markets, only a tiny proportion is sufficient to move the bullion market. The Bank for International Settlements (BIS), Organisation for Cooperation and Development (OECD) and European Central Bank (ECB) economists fear that a global excess of liquidity has caused either excessive valuations or bubbles in asset markets, including some equity markets, real estate, private equity and junk bonds.

So far, there hasn't been a marked increase in general global inflation, but with energy and other raw material prices still at high levels, many fear that there will be some price acceleration. Thus, there are enough investors around who distrust pricey financial assets and paper money, and require a hedge. They are buying gold even though prices have surged by 147 per cent from its 2001 low of US$255 an ounce.

The US dollar is currently weakening because the market expects US interest rates to either stabilise or slip in a slower US economy. The stubborn balance of payments deficit has hardly been dented. Devaluation has not worked because most of the depreciation has been against Europe. From its peak in February 2002 to the end of November 2006, the US dollar has slid by 31 per cent against European currencies, according to the Federal Reserve Bank of Atlanta.

But against Asia-Pacific nations, the decline has been only 13 per cent. In other words, the euro and other European currencies have risen substantially against Asian currencies. The appreciation of the euro, sterling and other European currencies against the US dollar, yen and other Asian currencies places pressure on the region's exporters and economies. European central bankers are threatening more interest rate rises. But some time in 2007, economies may be doing so badly that they may well be forced to cut rates. That, in turn, could lead to a setback in those currencies.

There are constant rumours in the market that Middle Eastern countries, led by Saudi Arabia, are diversifying surging foreign exchange reserves, which are mainly in US dollars, into gold. The same applies to China. According to the International Monetary Fund (IMF), the US Federal Reserve Board held around 8,000 tonnes of gold at the end of September. The Euro area nations, together with Switzerland and the UK, around 13,000 tonnes. China, which recently raised its gold holdings, has only 600 tonnes and Saudi Arabia, 143 tonnes. Russia has increased its reserves slightly to 385 tonnes. It is of little surprise that there is talk that some of the new found wealth of these nations could find its way into gold.

In the 80s and 90s, European central banks began selling their gold and Gordon Brown, UK Chancellor of the Exchequer, is constantly reminded that he decided to dump Britain's gold at rock bottom prices.

Now that prices have risen, embarrassed central bankers - who are human after all - are unlikely to be keen to sell. But if gold continues to surge on speculative trading, jewellery demand will fall and hoarders could take profit. Then supply could overtake demand and price will fall. Thus gold itself is a imperfect hedge against instability.

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