If It’s Good as Gold, How Good Is That?

It’s a good bet that no pharaoh, king or emperor who ever coveted gold--and didn’t they all?--could have imagined a day when the untarnishable ore would be viewed as just another commodity.

“Not in my pyramid, pal,” Ramses II would surely say.

Yet as gold’s price has fallen to 3 1/4-year lows over the last week, ending Friday at $355.70 an ounce in New York futures trading, the words used to describe the metal show little respect for its place in history, let alone for its future potential.

An anachronism, some investment professionals are calling it. Gold is “no longer a factor” in the realm of financial markets, one Wall Street veteran says flatly.

And then there is the C-word. The idea that gold is essentially no more significant than copper, soybeans, lumber or other such commodities--just more expensive per pound--has been uttered increasingly in the 1990s. But the word had never cut so deeply as when it was used by Peter Klauser, director of the Swiss National Bank, late last year.

The modern Swiss have always held gold dear. Their currency, the franc, is still tied directly to the metal. Swiss law requires the central bank to keep physical gold covering at least 40% of the value of currency notes outstanding--a simple way to keep the government from printing an excessive amount of currency, which would risk fueling inflation and economic ruin.

So gold to the Swiss has long been synonymous with stability, safety and prosperity. Which, coincidentally, also is Switzerland’s image to the world.

But in a paper written in November, Swiss central bank director Klauser questioned the logic of the bank’s still-strong tie to the metal--and in so doing, he offered food for thought for central bankers and all other gold owners.

Today a currency’s value, Klauser wrote, “is simply a [measure] of trust in the government that issues it.” The prices of gold and currencies, he pointed out, now “are determined in quite separate markets.” Gold, he said, “has become a tradable good, a commodity.”

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For Americans who remember that President Nixon cut the last link between gold and the dollar in 1971, Klauser’s words may not seem much of a revelation. But coming from a Swiss, that kind of talk suggests that gold has never had a greater public relations problem than it does now.

As a form of ornamentation (i.e., jewelry) for humans, gold’s role seems quite secure. Jewelry demand--which is 80% of total demand--has actually outpaced mine production in the 1990s. The other 20% goes for industrial uses and coins. Any shortfalls in supply have been made up from scrap and by the world’s central banks, which have been net sellers in recent years.

Commercial demand for gold is not the issue. What is at issue, more than ever before, is whether gold belongs in investment portfolios--as the traditional bulwark against economic or financial crises--and whether it belongs in central bank vaults as a manifestation of a country’s accumulated wealth.

The rap on gold is similar to what might be said about a worker left behind in a rapidly changing industry: Either the subject “can’t get the job done anymore,” or there no longer is a job, period.

Gold used to be the investment to which people ran in times of crisis. Its modern-day peak was reached in 1980, when it spiked to $850 an ounce on panicked buying by investors who feared that the United States was on the verge of hyperinflation. (Ah, the ‘70s!)

Yet since then, gold’s response to world crises has been increasingly muted. When Iraq invaded Kuwait in 1990--a huge shock to the world--gold rose a mere 20%, and just as quickly pulled back, well before the war began.

Other crises have come and gone in the 1990s, but gold, for the most part, has not been their beneficiary. “Can’t get the job done,” one might say of the metal.

But on another level, maybe there is no job for it anymore. Gold is the classic hedge against inflation. But inflation is the missing person of the 1990s. And, therefore, financial assets--stocks and bonds--have been the assets of choice worldwide.

Gold’s price is no higher today than it was in June 1990. The Dow Jones industrial average, in contrast, has risen 135% since then.

Moreover, if you’ve owned physical gold (say, coins) since 1990, you’ve probably incurred costs to store it. As an investment, gold hasn’t paid you--you’ve paid it.

For the Swiss central bank and its peers worldwide, gold’s direct and indirect costs have become a major issue. Rather than buy more gold with their growing financial reserves, many developing countries have chosen to invest those reserves in a liquid asset that pays interest: U.S. Treasury securities.

To some purists, this is, of course, the height of folly--backing paper currency with another piece of paper. What if the dollar and U.S. stock and bond markets all collapsed tomorrow? Wouldn’t gold have the last laugh? Aren’t there more than a few Mexicans today who wish they’d held gold rather than pesos since 1994, as their currency lost 60% of its value?

Certainly, one can paint scenarios wherein mankind would clamor en masse for gold again. But as Bill Martin, manager of the American Century Global Gold mutual fund puts it, “You have to be talking about something pretty horrific.”

If, instead, you’re just talking about a gradual rise in inflation, gold still might benefit. But how much? There are so many other ways for investors to hedge a portfolio against inflation today: energy stocks, real estate investment trusts and all manner of commodity futures and options. With capital flowing easily around the globe, investors in some countries who once bought gold for lack of other ideas have plenty of them now.

Finally, consider the basic supply-demand equation for gold if the world can stay in low-inflation mode. New gold discoveries worldwide have been eye-popping in recent years, especially Indonesia’s giant Busang deposit. New finds can make winners out of some gold-mining stocks, which is what fund managers like American Century’s Martin and Invesco Gold fund’s Dan Leonard typically are hunting for. Those new finds, however, also make Martin, Leonard and other fund managers wonder how much fresh ore may come to market over the next decade.

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Meanwhile, standing in the wings are the world’s central banks, which still hold the equivalent of 15 years’ worth of mine production. They will never sell it all, or even most. But they have been net gold sellers throughout the 1990s, a constant depressant on the price; indeed, the Dutch central bank last week revealed that it had sold one-fifth of its gold reserves last year.

Now the Swiss too are asking what role gold should play in a modern society and financial system. Gold’s fans might argue that Swiss misgivings about the metal are the ultimate contrarian signal that gold’s price has bottomed.

But as Andrew Addison, a technical markets analyst--and gold bear--notes, “Maybe this is one of those times when the consensus opinion is right.”

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Lost Luster Gold’s price has been stuck in a narrow range since the late 1980s, and has failed to get a significant lift even from international crises such as Iraq’s invasion of Kuwait in 1990. Quarterly closes, and latest, for nearest-term futures on the New York Commodity Exchange, per ounce: Source: Bloomberg News