x Abu Dhabi, UAESaturday 20 January 2018

Cautionary tale may be written in the rise of gold

Gold is a devilish sort of thing, Walter Huston's character Howard noted in the classic film The Treasure of the Sierra Madre.

Gold is a devilish sort of thing, Walter Huston's character Howard noted in the classic film The Treasure of the Sierra Madre. It drives people to rash acts, like the famous jig Howard danced when he and his cohorts finally discovered some. The problem isn't gold; it's the price of it. Gold surged this week to more than US$1,000 an ounce, the highest price since March of last year, when it reached an all-time high of $1,032.70.

Chances are that, even if you used to be, you are no longer worth your weight in this increasingly precious metal. Howard observed that gold "ain't good for nothing except making jewellery with and gold teeth". So, unless you're a rap star or are planning a traditional wedding, there are really only two reasons to buy gold. The first is as a hedge against inflation, when an economy grows so fast that prices skyrocket and money starts to lose its value. The second is as a hedge against political and social upheaval, when governments wobble and money starts to lose its value.

In either case, it's always good to have a little gold around. The only times in the recent past that gold has even come near the $1,000 mark was when investors feared either of these two outcomes. Back in March of last year, amid the global liquidity bubble, inflation was rampant and many feared that the dollar and other currencies might start to lose their, well, currency. The next time gold flirted with the $1,000 mark was in mid-February of this year, at the height of the financial crisis when many people thought the world, or at least the global economy, might be ending.

So what's up now? Many economists believe the global economy is on the brink of recovery, thanks in part to massive co-ordinated spending by governments around the world. Some governments, notably the US, have been borrowing the money they want to spend, and then printing the money they want to borrow. This confetti-like explosion of legal tender tends to cause people to question the adage that money does not grow on trees. The result is that the currency in profusion tends to lose its ability to purchase other things, such as other nations' currencies, or groceries, or commodities such as oil, or - you guessed it - gold. This results in inflation.

So, many analysts have been quick to explain gold's latest surge as symptom of investor expectations that inflation is likely to accelerate. And there is evidence in support of this conclusion. The dollar has been sinking against other currencies. The price of inflation-indexed US Treasury securities has been edging up, another sign that people think the risk of inflation is rising. Add to this pledges from the Group of 20 developed and emerging economies to continue fiscal stimulus, even as signs grow that the global economy is recovering, and it's easy to see why inflation-averse investors might be going for gold.

But does the spectre of inflation loom as large now as the last time inflation fears drove gold above $1,000 an ounce, back in March of last year? March, just a few months before rising prices sparked riots around the world? Hardly. There is another group of analysts and economists, therefore, that worries that gold's rise might be an omen that recovery is not upon us, and that economic conditions, or at least investors' perceptions of them, might soon resemble those dark days of mid-February.

What troubles this group most is that even as gold rises, yields on US government bonds are falling. If the investment community were worried about US dollar inflation, the price Washington has to pay to borrow should be rising, not falling. But the yield curve for US Treasury bonds has been flattening of late as long-term bond yields fall relative to short-term bond yields, a classic signal of a slowing economy that comes as investors seek the long-term stability of US debt and bet that deflation, not inflation, is the bigger risk.

The last time that gold prices started rising as Treasury yields fell was late last year, when the financial crisis erupted and the Apocalypse seemed nigh. Gold outpaced bond yields until about June, when the two re-established what some economists say is a natural embrace. Then about a month ago, for reasons that remain unclear, the two diverged again, with gold climbing and Treasury yields sinking.

Now, it could be that all of this means absolutely nothing. One of the most important lessons that needs to be relearned from this crisis is that markets are not rational. Neither are market prices a reliable tool for predicting economic trends. What markets are good at is gauging the mood of investors, whose perception of where the economy is headed can become a self-fulfilling prophecy. So, like a card player who finally discerns an opponent's "tell" - which reveals their intentions - the people worried about the divergence between gold prices and bond yields fear they may be witnessing misgivings among investors about whether the global economy really is on the verge of recovery.

After all, the most bearish of economists, the ones who not only predicted the crisis but also correctly foretold its severity, still warn of the dangers of a "double-dip" recession. They say the recovery is unlikely to resemble the boom in markets since March, but will rather be agonisingly gradual. And for every piece of data that leads us to conclude that the global economy's glass is half full, there is another that reinforces the dismal realisation that it might be just as empty.

One that immediately comes to mind are the latest US jobs data, which showed that unemployment in the world's largest economy is at its highest level - almost 10 per cent - since 1983, and still rising. Markets chose to focus on the fact that the jobless rate is rising at a slower rate, suggesting that unemployment might soon stop rising altogether and reverse directions. But what if it doesn't? Without jobs, the US consumer is unlikely to resume spending.

And few economists believe Asia, despite its China-led recovery, can survive for long without the US consumer. Oil prices, which are rising alongside gold, depend to some extent on Asian demand, and the Gulf, despite its best efforts, still depends on oil prices. "Now here's where we're bound for, hereabout. Don't show properly whether there's mountains, swamp or desert," Howard the movie character observed some 60 years ago. "That shows the makers of the map themselves don't know for sure."