Head-scratching

The puzzle ring is an enduring and attractive novelty: gold rings, linked together, that intertwine to form a single complex piece; and a neat symbol for the present gold market.

It is a neat symbol because the current market is a puzzle, if nothing else. At a time when the “crisis premium” should be locked into the gold price, bullion has faltered; gold equities are at their lowest since last July. It’s reasonable to wonder just what is going on.

At the time of writing we are, perhaps, hours away from war in the Fertile Crescent. Yet the gold price hovers at around US$335 per oz., far off its US$382.10 peak in February, and even looks to be on a downward trend line.

This is not what should have been happening in the gold market most of us know. The Middle East has historically been a heavy buyer of gold whenever life in the region promised to get uncomfortable. It is not hard to recall how the Iranian revolution in 1979, the Soviet Union’s invasion of Afghanistan the following year, and the Iran-Iraq war were critical events in the gold bubble of the early 1980s. Oil-rich Persian Gulf and Saudi Arabs were on the phone to London and Zurich daily, turning petro-dollars into hard assets. Anyone with a memory of those days would think that the same should be happening again.

Less often remarked on, but also mightily important, is the role of the Middle East as a way-station for gold destined for South Asia. India has always been a major importer of gold at the retail level; no Indian wedding is complete without it. That gold has for centuries come through the souks of Dubai, and any interruption in that supply line could be disastrous for Indian buyers — who, it might be thought, would be buying physical gold in advance against the possibility of problems in Dubai. So where are these Indian buyers?

There are a few possible explanations. The first is that tension or fear of war is not the same as uncertainty. In the coming conflict, the West — or more precisely those countries that have so bestirred their valour that they have actually shown up for the invasion of Iraq — is as near as anything comes to a sure thing. Sure things protect the value of paper assets. Sure things don’t interfere with markets.

A second factor is that oil wealth ain’t what it used to be. Saudi Arabia and the Gulf states were the envy of the world in the 1970s, when the oil shock was in everyone’s short-term memory. They have gone from leading the world in gross national income per capita, to the middle of the pack. If you’re going to buy gold, it helps to be rich, and the buyers of the early 1980s aren’t nearly as rich as they once were.

A third factor is the benevolence of the West. One distinguishing characteristic of modern-day international tension is that the good guys have at last seized the initiative. In 1980 it was possible to believe that the Soviet Union might drive to the Indian Ocean and that the mullahs might set the Near East on fire. Now Western democracies are setting the agenda, and those democracies are not given to shutting down trade routes or confiscating wealth, whatever the globaphobes may want us to believe.

That doesn’t leave gold with much upside — which is not always a bad thing. As much as high gold prices benefit the mining industry, longer-term prosperity and safety will benefit the industry more. So what is the case for a bull market in gold without the crisis premium to hang our hat on?

Reserve currencies, that’s what. If — as gold bulls have always maintained — gold is a currency and not a commodity, then gold will rise as other currencies fall, simply through the magic of long division.

We are at a stage where all three major reserve currencies — the Japanese yen, the euro, and the U.S. dollar — are being viewed as either overvalued or structurally weak. Interest rates are low throughout the developed world, but equity markets are stagnant. The old knock on gold — that it earns no interest and pays no dividends — is now true of most investments.

There may be no crisis premium, but weakness in paper currencies has always been a good sign for gold.