Gold has delivered remarkable investment returns, from 2001 to 2011 it has increased fivefold, analyst are now predicting that the shiny metal will hit $2000 an ounce by next year. It has come to astonish me that this worthless lump of metal whose value is “in the eyes of the beholder” is becoming a staple for every investor’s portfolios. John Maynard Keynesreferred to gold as the “barbarous relic,” I agree, it has become an asset class bought on the assumption that there is a “greater fool” willing to pay a higher price for it.
Nearly every day you’ll see a financial professional or journalist extolling the virtues of gold. The reasons for investing in this precious metal are well established, the five justifications typically repeated are usually:
- It is a protection against inflation.
- It is a hedge against currency devaluations.
- A safe haven in times financial market instability and deep uncertainty.
- A vital way to diversify ones portfolio.
- The fundamentals of demand and supply support higher prices.
Whilst some of these don’t stand up to scrutiny, most are legitimate reasons, but is it rational for investors to pile into a mainly worthless metal when they could be channeling their scare capital into businesses that create wealth? The euphoria for this asset class is reminiscent of the dotcom and property bubbles. Even George Soros, one of the greatest hedge fund managers in the world referred to gold as the “ultimate bubble,” he says “it is certainly not safe and will not last forever.”
I believe gold is caught up in a gigantic bubble, one that is similar to the south sea bubble and the tulip mania. Its chief driver is financial and technological innovation, gold was previously only traded through dealers and street shops, now it is traded predominantly through exchange traded funds over the internet. ETFs which are derivatives that give retail investors easy exposure to gold is a significant financial innovation and the major difference between this gold bubble and previous ones. According to the World Gold Council (WGC), investment demand (ETF’s plus bars and coins) accounted for 35% of total demand in 2010; this is compared with less 10% in 2001. At the same time jewelry demand has continually declined, falling 18% from 2004 according to the WGC, this now makes ‘investment demand’ which is driven by collective investment vehicles like ETFs one of the biggest…
