Lord William Rees-Mogg (Fleet Street Invest UK):
In the last six months there has been a rebound of 50% in the great majority of world stock markets.

There has also been a comparable rebound in the price of oil, with West Texas oil rising very close to $80 a barrel. In the oil market there has been heavy two-way trading in options. There could be a sharp spike in the oil price if speculators have to cover their positions.

At the same time the US dollar has remained weak, and now stands at $1.4886 to the euro and $1.66628 to the pound. This is close to a 14-month low on a trade-weighted basis. The poor performance of the dollar reflects the low US interest rates and the twin US fiscal and trade deficits.

The demise of the dollar

The dollar nevertheless remains the world’s leading reserve currency, with the euro in second place. Investors are naturally anxious to protect themselves against markets, including currency markets, which have shown such a high degree of volatility.

The Chinese, who have the greatest number of dollars in their currency reserves, have already suffered substantial losses.

In what amounts to a crisis of the dollar, the euro is in second place as a reserve currency, but there are potential threats to the future of the euro, due to the weak productivity of the Mediterranean economies. There is a big stretch in productivity growth between the German and the Southern European regions.

The fall in the dollar against other currencies includes a devaluation of the dollar in terms of gold, which now seems to have stabilized at a dollar price of $1,050 an ounce.

The circumstances do indeed appear to be uniquely favourable to gold.

Interest rates and therefore carrying costs are exceptionally low. The dollar is exceptionally weak. The technical market position is strong, including good demand for gold in terms of jewellery. The oil price – which is often linked to gold – is rising. Those who believe that oil is due for a further rise to $100 a barrel are likely also to be confident about holding a proportion of their investment . . .
Click here to read the rest of Lord Rees-Mogg’s article at Fleet Street Invest UK.

Gold’s stellar run up to $850 per ounce, rising more than 24 times over, also came in the ’70s. So gold, therefore, must deliver its strongest returns when the cost of living shoots higher. Right?

Wrong. “In the long run, stocks have thrashed gold as great long-term hedges against inflation,” says Jeremy Siegel, professor of finance at Wharton University, Pennsylvania. What’s more, the eight-year bull run in Gold Prices so far this decade has come against the lowest average consumer-price inflation since the early 1960s.

In short, the common opinion of gold as first and foremost a defense from inflation is wildly amiss. Just look at the last 30 years.

Consumer prices in the United States, even on Washington’s data, have pretty much trebled since 1980. But starting at what was then an all-time high of $850 per ounce, gold simply failed to keep pace. In fact, it dropped half of its purchasing power (monthly data) over that time.

At its lowest point, back in 2001, gold’s loss of purchasing power for US investors reached beyond 85%. The broad S&P index, on the other hand, stood more than eleven times higher, even as the Tech Crash pushed US equities into a nosedive.

Sure, things have reversed a little since then. But not enough to reverse the cold fact of gold’s losses during the long inflation of the late 20th century. How can we square it with gold’s huge returns amid the inflationary ’70s?

“Well,” you might guess, “perhaps gold only responds to rapid inflation – the nasty kind we got 30 years ago, rather than the ‘mild’ case our money has suffered ever since?”

But again, you’d be wrong – or very close to it. Between 1980 and ‘81, consumer price inflation in the US destroyed 17 cents of the Dollar’s purchasing power, a severe depreciation by any reckoning. Yet the Dollar price of gold dropped 40% during that same period. Longer term over the 1980s and ’90s – a truly horrific period of sustained inflation, then averaging 4.6% per year and vicious by any historical comparison – the real value of gold sank by more than four-fifths.

Look further back – even to when physical gold stored in government vaults underpinned the Dollar, just as it underpinned all major currencies – and you’ll find that gold almost always made a poor hedge against rising prices. In the mid-70s, Professor Roy Jastram at the University of California at Berkeley found that gold failed to keep pace with the cost of living during seven inflations in Britain across more than three centuries. In the United States, Jastram spied six inflationary periods between 1808 and 1976. On average, they saw the purchasing power of gold fall by more than one-fifth!

Only the final period in Jastram’s study – beginning in 1951 – saw the metal gain value, and it continued to gain purchasing power for the next 30 years. By the end of 1980, the average annual price of gold had risen more than 17 times over. But right from that top it was downhill for the next twenty years.

How come?

What changed at the start of the ’80s? Two things in short order, which were entirely connected.

First, Paul Volcker – the famously tall cigar-loving chairman of the US Federal Reserve – raised Dollar interest rates to nearly 20%. So secondly, and as a direct result, the rate of inflation sank from that record peace-time spike above 14%.

Volcker’s strong medicine took nearly two years to slow the rate of inflation. But it killed the Gold Price almost instantly. Before Volcker hiked rates – and before he and his successors gained ample room to cut them year after year – “There was a kind of great speculative pressure,” as Volcker since said. The Fed noted how “speculative activity” in the gold market was spilling into other commodities. One official at the US Treasury called the gold rush “a symptom of growing concern about world-wide inflation.”

So yes, people piled into gold as double-digit inflation and collapsing bond prices destroyed their savings at the end of ’70s. And yes, it took a record return paid to cash for the devaluation of money to slow down, allowing a cautious return to risk assets like corporate debt, listed equities and new private ventures – assets whose long-term appeal rests on stable costs and expenses, rather than a speculative guess at how the central bank might set its interest rates from one month to the next.

But now, in contrast, Britain stands on the brink, the United States will likely confirm it on Friday, and Japan’s pretty much there – yet again – suffering the horrors of inflation’s bleak evil twin, deflation.

How come gold just keeps hitting new record highs?

Before the 20th century, short periods of falling prices were as common as scurvy, and just as harmless for the long-term value of money and assets. Indeed, deflation is a good thing, for savers at least. Provided their savings institutions stay solvent. And provided their cost of living actually goes down faster than the value of the assets they’ve saved. Which is not what’s happening today. And that brings gold’s other key feature – the one investors should note if they buy it as a tightly supplied metal that shot higher in price when inflationary panic struck in the late ’70s.

Because fact is, gold also offers a deep, liquid market (if held in its internationally tradable form of large wholesale bars) with no risk of counter-party default (if owned outright, rather than through a trust or a fund or a similar financial structure).

In our debt-deprived world today – where the outstanding value of what retirees and savers are owed is deflating much faster than costs – it’s this attraction of gold…it’s “off risk” advantage…which is fast-gaining appeal amongst large funds and private investors alike.

Inflation and deflation – both a crisis in money – both also force business and growth to give up. What remains, paying zero and promising nothing, is the need to simply store wealth and savings for a better future, whenever it shows.

Source: Gold Amid Inflation & Deflation