Will the global stampede for gold bullion last?

When a huge gold-plated statue of a
sausage was unveiled in
the small Russian town of Novokuznetsk
, it seemed final proof the
world had gone crazy about this most precious of metals.

The salami sculpture was in fact a tribute to the town’s
favourite food. But the taste for gold is universal, with the price up 54% in
two years, according to the World Gold Council (WGC).

Last week, spot gold touched $1,343.90 (£842.81) an ounce
– an all-time high – with bulls forecasting it could top $1,500 by the end of
the year.

Gold has always been seen as a safe haven for investors
at times of economic uncertainty, so it should come as no surprise that,
following the dotcom bust and the financial crisis that
broke in 2007, its price has rocketed. But gold’s bull run goes back even
further and since 1999 the price has risen more than 430%.

It was in 1999 that the then chancellor, Gordon Brown,
dumped half of Britain’s gold reserves at an average selling price of $248 an
ounce. With hindsight, this looks like an awful mistake – these days central
banks are net buyers of gold after a 15-year selling spree.

Fears about the future are driving the price higher, says
Marcus Grubb, managing director of the WGC, as worries mount about sovereign
debt, currency devaluation (particularly the weakening of the dollar) and a double-dip
recession grip world markets.

Grubb says investors believe the US and possibly the UK
are about to embark on another round of quantitative easing, pumping money into
the system to prevent deflation but setting the scene for inflation, as
ultimately there will be too much money chasing too few goods.

“Gold is a hedge against inflation but is also being
used as a defence against deflation as countries are devaluing their currencies to boost
exports to get their economies back on track,” Grubb says.

Last week, Dominique Strauss-Kahn, head of the
International Monetary Fund, warned of a currency war if countries
manipulate their exchange rates to solve domestic problems. His comments echoed
those of Guido Mantega, Brazil’s finance minister, who said that
exchange-rate conflict threatened the global financial system

One analyst says: “Gold is being lifted by two important
factors – fear that the currency system is unravelling, and that more
quantitative easing will set the stage for inflation down the line.”

A third factor is that currencies are being debased in
the developed world, where sovereign debt is at record levels and bearish
commentators fear the dollar could slump 20% in the next two years. The picture
could be worse for countries on the European periphery such as Greece, Ireland
and Portugal.

But while the US and Britain are debasing their coin to
alleviate the pain of recession, China is holding its currency. the yuan, down
(to the fury of Americans) to ensure its huge manufacturing output can be sold
cheaply in world markets. Last week, Chinese premier Wen Jiabao confessed that
a 20% rise in the yuan would threaten
China’s social order. “I can’t imagine how many Chinese factories will go
bankrupt, how many Chinese workers would lose their jobs [in the event that
China revalued],” he warned.

Given this currency turmoil, it is easy to see why gold
has become so popular.

But how much further has gold got to go? Here, opinions
differ widely.

George Soros, who made millions betting against the pound
before it was forced from the exchange rate mechanism in 1992, described gold
as the “ultimate bubble”. He says: “Gold may go higher but it’s
certainly not safe and it’s not going to last for ever.”

Veteran US investor Warren Buffett is also sceptical
about gold, saying it is unlikely ever to interest him as a home for his money.
He says: “Gold gets dug out of the ground in Africa or some place. Then we
melt it down, dig another hole, transport it half way round the world, then
bury it again and pay people to stand around guarding it.”

But hedge fund manager John Paulson,
who scooped $4bn by shorting the US housing market in the run-up to the credit
crunch, is a goldbug with about 80% of his assets in the metal or backed by
gold-denominated shares. He is also a big investor in gold-mining companies,
with a 12% stake in Johannesburg-based AngloGold Ashanti and a large holding in
Kinross Gold.

Paulson says the gold price could hit $2,400 an ounce
following monetary expansion by the US Federal Reserve, and as high as $4,000
based on a projected overshoot.

Here is what Paulson sees coming: low double-digit
inflation by 2012, killing the bond market, and restoring strength to equities
and gold; US economic growth capped in 2011 and 2012; a weak US housing market;
currency mayhem; and continued dollar weakness as Washington struggles to
tackle its debt.

But Joel Kruger of the currency group Daily FX says he
would not recommend gold at this price. And he reminds investors that gold pays
no interest, income or dividends, meaning that you are relying solely on
capital growth.

That has not stopped wealthy private investors piling
into gold. Tony Dobra at Baird & Co, the London-based gold supplier, says
turnover doubled last year to more than £300m and was already at that level by
the end of last month – which means a bumper 2010.

Dobra says: “Gold bars weighing between 100g and
1,000g are very popular at the moment but we also deal in bars that are quite a
bit heavier.”

UBS is advising high net worth clients to hold 7% to 10%
of their assets in precious metals. UBS executive Josef Stadler says:
“Fears of a double-dip downturn have boosted the appetite for physical
bullion as well as for mining-company shares and exchange traded funds [which
are backed by physical gold].”

Deep beneath the Swiss Alps, nervous Germans are storing
gold in former military bunkers. Mindful of the hyperinflation that wreaked
havoc in their country during the 1920s, German investors have been at the
forefront of gold purchases in Europe. Many of them are keen to store the
precious metal outside banks, which have been distrusted since the onset of the
credit crunch, and Switzerland is cashing in on those concerns. Old military
bunkers in the Bernese Oberland now serve as maximum-security vaults for
nervous Europeans.

But it is not just investment funds and retail investors
that are pushing the gold price higher. Central banks have been piling in too:
China, India, Brazil and Saudi Arabia have been bolstering their stocks, not
least as a hedge against the falling US currency – most of China’s reserves are
denominated in dollars.

For years, central banks were net sellers, accepting the
assumed wisdom of the time that it is more profitable to hold sovereign debt
instruments, with their steady returns, than non-yielding gold. That philosophy
has been turned on its head. The sovereign debt crisis, the declining strength
of the dollar and currency wars give credence to Grubb’s assertion that
“gold is a store of value in the long term”. Intriguingly, he points
out gold would be trading at $40,000 an ounce if the dollar were still pegged
to the gold standard, as it was prior to the collapse of the Bretton Woods fixed
exchange rate agreement in 1971.

Few believe gold will reach those levels again but bulls
say Asian central banks could become big buyers, not merely to shield
themselves against the weak dollar but also because of gold’s intrinsic worth.
They say countries such as Brazil and China have only about 5% of their
reserves in gold bullion, compared with 50% in parts of Europe.

But a sudden shift by central banks is impossible, as
global supplies of gold are limited. China, for instance, holds only 1.7% of
its global reserves in gold; to increase that to 15%, it would need to buy
8,000 tonnes, or 110% of last year’s total global output. So any lift in
China’s exposure is likely to be gradual.

Bears warn that the price could tumble if economic
recovery and financial stability take hold. But that looks a long way off from
where we are today, so the bulls are in the ascendant. For now.

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