x Abu Dhabi, UAEMonday 24 July 2017

When the going gets tough, gold gets going again

While the world will not return to a gold standard, Greece's problems give the precious metal much-needed attention.

While the world will not return to a gold standard, Greece's problems give the precious metal much-needed attention.
While the world will not return to a gold standard, Greece's problems give the precious metal much-needed attention.

"Oh Gold! I still prefer thee unto paper Which makes bank credit like a bank of vapour." When Lord Byron penned those words in Don Juan nearly two centuries ago, I am sure that he would have been horrified to think that they would be quoted in the distant future by a middle-aged man sitting in a bank. That would be particularly so as they preface an article about the current woes suffered by Greece - a country he fought for against the Ottoman Empire and where he is revered as a national hero.

Whatever Lord Byron had in mind while he was writing these lines, they are rather apposite at a time that has seen Portugal, Spain and Greece have their debt downgraded. In the case of Greece, it has now been graded as "junk". Over the course of last weekend, the Greek government warned of large sacrifices the public would have to make and freed up ?120 billion (Dh562.61bn) in aid. In a perfect world, which probably precludes human involvement, that would be the end of the story.

But the reluctance of the Greek population to pay the debts of their parents, as it has been characterised by some protesters, means the political situation is likely to remain volatile. Therefore, while the political rhetoric now may be all in terms of a crisis averted, there is little doubt there remains considerable scope for further negative headlines on sovereign debt, and not just concerning Greece, as analysts investigate all countries that are seen as running excessive deficits.

Moreover, any hint of default or restructuring is going to focus attention on investors, including banks, and the implications of what such an outcome could have on their financial well-being. Indeed, in probably the most colourful imagery of this entire crisis, Jose Angel Gurria, the secretary general of the Organisation for Economic Co-operation and Development, said the situation was like having an infectious disease. "When you realise you have it, you have to cut your leg off in order to survive," Mr Gurria said, before adding that current events are "threatening the stability of the financial system".

In a situation such as this, traders generally only have one default setting and that is to sell. Often there is little differentiation across markets but more simply a desire to retreat a safe distance and wait till the dust settles. Gold has tended to be no different: the knee-jerk reaction has been to search for bids and then watch the price creep back higher in subsequent days. A useful way of looking at this has been by referencing the various gold exchange-traded products around the world. Many analysts have categorised these as a form of insurance, which is certainly partly right. The concern has been that when someone suffers a loss they contact their insurance company - in this instance, selling gold to cover their losses elsewhere.

There is now some 1,837 tonnes of gold held in these vehicles, which is a not insignificant amount. To put it into context, it is three quarters of global annual production of the metal, more gold than China holds in its reserves, nearly 13 times that held by Saudi Arabia and an astonishing 150 times as much as is declared by the Qatar central bank. So as the debt of three euro zone members was downgraded, there were fears that a metal that is revered for not being anyone else's debt could suffer in the short term, even while market conditions demonstrated the attractions of having investments outside the financial system.

Despite these possible problems, and a rising dollar, the yellow metal managed to rally: a rise of 3.5 per cent on a day when stock markets fell about 2.5 per cent and aluminium the best part of 7 per cent. The rise has continued. I am not suggesting the path for gold is going to be a smooth and uninterrupted move higher. But I do think that this marks an important moment in the history of this metal.

I believe the implications are twofold. The first is that it shows the allocation into gold is part of a longer-term trend: investors making a decision to hold part of their assets in gold as diversification. The second is that it demonstrates investors are not as long on gold as some pundits have suggested. This is a secular move into gold and one that is unlikely to disappear any time soon. One final consequence of these events is that there is going to be increasing demands to curb what might be seen as excesses in the systems, something that can only be cured by a return to financial discipline.

A favourite channel for this sort of argument is a return to a form of gold standard where the responsibility for debt and an expanding money supply is taken away from politicians and given to an instrument that cannot be influenced by political whims. Personally I think it is inconceivable that the world could return to a pure gold standard. What I feel is likely, though, is a metal that was abandoned and dismissed 10 years ago, and was threatening to break through 20-year lows below $250 an ounce, making headlines for the right reasons as it makes fresh all-time highs.