Gold: is it really near a record?

In inflated dollar terms, gold’s all time high in 1980 is actually the equivalent of $3,129 in today’s money, but relativity relates to choice of currency and statistical start point.

LONDON - 

With gold grabbing the headlines in the "lay" press as well as the specialist publications and law-abiding analysts being buttonholed by their mates about whether it's now a "buy", it is perfectly arguable that the market is topping out.  While this is unlikely actually to be the case this time, there is clear scope for a correction, as speculative froth needs to be blown off the market. Many market observers expect the spot price to challenge the historical high within a matter of days.  The record high fix was $850 on 21st January 1980, although the intraday high was closer to $875.

The reasons behind the moves are obviously well rehearsed, including continued dollar concerns, geopolitical tensions, oil heading towards $100 per barrel, associated inflationary fears and concerns (potentially misplaced, given balance sheet strength) about the banking system, volatile equity markets and underlying financial stability.  Perception is all and it is the fears surrounding the banking sector that are exacerbating the problem (the run on Northern Rock in the United Kingdom is a case in point).  The sector that may actually have the real problems is the financial insurers, who are likely to incur substantial losses against loan write-downs. 

Gold, that other insurance policy, has accordingly gained 28% between the recent intermediate low fix of $653.00 on the morning of the 17th August and the pm fix of $841.10 on 7th November.   This increase is in dollar terms rises in a selection of other currencies have been as follows (taking the low pm fix, 21st August, through to the pm fix of 8th November).  The gain in yen terms was 26%, while the gain in Australian dollar terms was a mere 10%, as the Australian dollar been benefiting from commodity strength (although the recent hike in Aussie interest rates may also have helped here).

The table below, meanwhile, shows how the local currency equivalent of the pm fix on 8th November compares with the equivalent on 21st January 1980.  It can be seen that in the major currencies, with the exception of the euro (synthetic conversion) gold is still a long way short of its all-time highs, while in rupees it has risen by a factor of almost five and in rand terms by almost eight times.   

Furthermore in inflation-adjusted terms, gold is nowhere near an all-time high.  This can be looked at in two ways; either, what would $850 in January 1980 be equivalent to today; or, to what would the pm fix of 8th November of $841.10 be equivalent in January 1980?

Deflating by the US Consumer Price Index shows that in 1980 money, the 8^th November 2007 fix would be equivalent to approximately $3,129.  Conversely, in today's money the January 1980 high would have been equivalent to $228.7.  In other words, when adjusting for inflation, gold has fallen by 73% in dollar terms. 

It must be borne in mind that these exercises relate purely and simply to the 1980 spike in gold's price, which was extreme, and therefore must not under any circumstances be interpreted as suggesting that gold has been a long-term underperformer.  Time series can obviously be commenced at any point; for example, since the low pm fix of $252.80 on 20th July 1999, gold has increased by more than three times in dollar and yen terms, and by between two and 2½ times in euro, Swiss francs and the major producer currencies.  In Indian rupee terms gold has risen by a factor of just less than three and in Turkish lira, by a factor of almost nine.

The markets are understandably excited about gold's recent heady performance, but it should really be put in context.  This is almost as much a dollar story as it is of anything else; although this statement of itself is somewhat disingenuous since the performance of the dollar is frequently a measure of confidence, or otherwise, in economic and financial circumstances.  Gold's correlation coefficient with the trade-weighted dollar has, since the intermediate low on 21st August, been minus 97%, showing how very important the relationship has been.  Since the 1999 low, it has been more moderate, at minus 75%. 

Meanwhile with the physical market notably subdued in the face of high and volatile prices there is every possibility of a correction, quite possibly a sharp one, before any renewed strength.  The physical markets will return, of that there is no doubt, but India and the Middle East need to be coaxed back into action if the speculative domination of the market is to be diluted.

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