In January 2007, the gold price was around $600 an ounce; at the end of January 2008, the gold price touched a new peak of $929 an ounce. That is a rise of 50 per cent in twelve months. The rapidity of the rise invites the question whether it can be sustained.
I have expected for some years that the gold price would in fact rise to $1,000 an ounce, and I still regard that as a reasonable forecast. But even $1,000 an ounce no longer looks all that impressive. It is the equivalent of about $400 in real terms, if one takes 1980 as the base year. To reach a new high in real terms, gold would have to rise to about $2,500 an ounce, and that is still a long way off.
The latest gold price increase has been caused by anxieties about the power supply crisis in South Africa. The normal rule of investment would be that interruptions of the power supply are likely to be temporary. In terms of labour militancy, a power close down is like a strike, and the rule is “buy on a strike, sell on a settlement.” However, the electricity supply situation in South Africa is particularly worrying for the long term, not just the short term.
The South Africans have in the past supplied electricity to Zimbabwe, which has had to be cut off, accentuating the economic crisis of the Mugabe regime. The cause of the shortage is the failure of South Africa to build the new power stations which the South African economy requires. It takes a decade or so to develop a major electrical supply programme. There has also been inadequate maintenance. Local observers think that there will be a considerable delay before an adequate supply is available in the gold mines. There will not be a quick fix.
However, the price of gold is influenced by many factors, of which physical supply is only one. Gold is a unique commodity in that well over 90 per cent of all the gold even mined is thought still to be in existence. Obviously this is true of bullion, but it is also true of jewelery. There are, of course, industrial processes which effectively destroy the gold they use, but even then the metal is so valuable that it pays to recover and reuse it where possible.
Normal price schedules assume a relationship between production and consumption which does not determine the price of gold. The best way to understand the gold market is to regard gold as a kind of shadow currency, competing with national fiat currencies, and influenced by expectations of inflation and global movements of interest rates. However, this is pretty complex. For instance, the fear of recession, such as exists at the present time, normally produces expectations of lower interest rates, which will reduce the carrying cost of gold, and tend to raise the gold price. Yet the fear of a recession is, essentially a fear of deflation, and gold is regarded as a hedge against inflation. Historically the demand for gold is not determined by any single factor, except possibly for fear. Gold can be seen as a defence against a number of different threats.
At present, the weakness of other currencies, particularly of currencies normally used as reserves, is probably the strongest reason for gold’s long term rise in dollar terms in that the world has too many dollars. That situation seems unlikely to change in the near future. If confidence in the dollar is genuinely restored, that will be the day to sell gold. It is a day which still looks a long way off.
Markets and Money