Sent: 17-11-2009 08:55:02
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The Purchasing Power of Gold
The rise in gold prices is nowhere near as startling as how little gold prices have risen.
"Gold fever sweeps an anxious world" was one of the headlines in Australia's leading financial daily in the last week. The rationale behind its rise featured in another headline: "If all fails, it wins".
Articles in editions 57 and 58 of the monthly ATC Digest canvassed some of the reasons for investing in gold as well as some of the shortcomings from using it as an asset class.
The hedge against a weakening U.S. dollar has become the predominant rationale for a rising gold market. For the medium term, some investors have also been seeking to safeguard against a rise in global inflation. Others are looking to protect assets against the risk of a systemic failure among financial institutions.
Behind these uses of gold is a perception that it can hold its value better than alternatives. Far from being a leading contender to fulfil these functions, the main point of this note is to highlight how poorly gold prices have kept up with the pack.
Central banks are supporting asset values through their impact on global liquidity conditions and, in doing so, are providing one of the most benign environments possible, given underlying levels of economic activity, for commodity prices generally. The Indian central bank has also done its bit for gold by taking up the bullion being offloaded by the International Monetary Fund.
Since January 2002, gold prices have moved up 302% but copper prices gained 339% and oil prices increased 306%. Since the cyclical low point in these markets in late 2008, prices have risen 49%, 103% and 81%, respectively.
The charts at http://www.thebigpicture.com.au/atc/au_purchasing.htm show the purchasing power of gold measured in terms of physical copper and oil over the 25 years since 1985. An ounce of gold bought an average 371 pounds of copper or 17 barrels of oil. Even with gold prices pushing to record levels, gold's purchasing power is below these long term averages by 13% in the case of oil and 2% in the case of copper.
Notwithstanding a vibrant and unrelenting cheer squad, gold does not have a history as a superior commodity hedge.
Gold would have once been favored over oil and copper because it was more conveniently stored than the other two commodities. Especially for oil, storage can be expensive but, in recent years, new instruments have been created through which even retail investors can gain cheap exposure to these commodities.
That is not to say that gold prices will not rise. Most of the principle indicators are pointing in the right direction. However, that applies to a broad range of commodities.
Gold now faces additional risks arising from its role as a short term trading instrument. Any unwinding of U.S. dollar short positions could see its recent gains reversed. This could happen, for example, during the U.S. recovery phase in 2010 as interest rate expectations begin to change.
While other commodities should benefit from an acceleration in global growth during 2010, gold is relying heavily on central banks for some of its strength. If any other product relied so heavily on this single prop - official bank holdings account for 12 times annual production - the AFR journalists would be discussing its investment shortcomings not hailing its potential.
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