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The Economist Questions the Rise in Gold Prices

Excerpt from The Economist article titled Gold: Store of Value

…The wretched state of many governments’ finances makes some worry about states’ ability to repay their debts—or about the temptation to inflate them away. Banks’ exposure to sovereign debt and to a still-fragile world economy adds another layer of concerns. And when all governments would like their currencies to be weaker rather than stronger, whose paper money do you trust? Hussein Allidina, head of commodities research at Morgan Stanley, reckons: “Gold looks better every day with growing sovereign risks.”

Some gold bulls argue that the long-term prospect for gold prices is bright even if these fears subside. Income per person in China and India, the biggest markets for jewellery, is racing along, the reasoning goes, and this should support the market.

But the price surge has had others shaking their heads. As an investment that does not produce income, its attraction lies solely in the hope that its value will rise or at least be maintained. As a metal, its main use is in jewellery. It defies logic, say the bears, that its price should remain so high without any fundamental change in the sources of demand or constraints on supply. Willem Buiter, a former professor at the London School of Economics who is now the chief economist of Citigroup, has called gold the subject of “the longest-lasting bubble in human history”. He says that he would not invest more than a sliver of his wealth “into something without intrinsic value, something whose positive value is based on nothing more than a set of self-confirming beliefs.”

At the root of this debate about the durability of the gold-price rally are different beliefs about the future path of demand and supply. There have been notable shifts on both sides of the market, serving to push up the price of gold. These predate the global financial crisis: between 2003 and 2007, when some investors were already beginning to doubt the sustainability of the boom in property and share markets (as well as the wisdom of monetary policy and the prospects for global growth), the price more than doubled. But since the crisis these doubts have intensified, generating the recent leap in the price.

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