…a go run him belly.'* This, for non-West Indian readers, is a Jamaican proverb cautioning that what tastes oh so sweet now does not digest too well later. Think asset backed securities and Citigroup, for example.

But also bear it in mind, maybe, when considering investing in, rather than simple hedging with, bullion (though it’s doubtful the downside runs would be of subprime severity).

Is gold an especially attractive asset right now? There are reasons to think so:

  • recessionary global conditions and systemic weakness in financial systems in the US and EU are pushing interest rates down. The relative cost of holding physical gold over sovereign bonds is thus particularly low;
  • bullion is safe harbour against volatile equities (and financial systems), an asset with no counter party worries;
  • few signs that mine production is set to materially increase. [An aside - my personal nightmare is, having loaded up on gold, waking up to headlines that South Africa’s Gold Fields, for example, have discovered an enormous vein 50 metres below the surface (rather than at their current 3,000m depth) and doubled the world’s known reserves at a stroke. However, despite technology and miners’ best efforts that has not happened. Yet];
  • poor, apparently, dollar prospects. Over 60% of the change in the price of gold is explained by movement in the dollar/euro rate. With the Federal Reserve and US Treasury flooding the banking system with liquidity the chance that they fail to mop up it all up in time to stop inflation once expansion starts is a gold catalyst in waiting. However, this is not entirely convincing - there is also reason to believe that, in relative terms, the dollar economy may end up faring better than the euro area;
  • lower energy prices, while not doing much for bullion, should be improving miners’ margins making them an attractive proxy; and
  • with rumours swirling of eventual diversification out of dollars and into gold by Asian central banks, there is a potential shoot the moon deal for gold bulls

On the other hand, gold is not only a store of value - it is also a genuine commodity. There are industrial and commercial (jewellery) markets for it and these are also sensitive to market cycles (ie this demand element is down).

Then there are the stories of ongoing forced gold sales to cover losses of other asset classes. Furthermore, and despite the Central Bank Gold Agreement (CBGA) which aims to minimise market disruption, should a sovereign government decide to join this action – and with Keynes partying like mad there may be the temptation - there would be significant downward pressure on bullion.

This includes the potential action by the IMF, party to the CBGA and third largest official holder of bullion, to dump stock (pending US Congressional approval). Originally conceived in late 2007/early 2008 as a way to strengthen the organisation’s finances the growing role of the IMF in stabilising member nations might, possibly, widen the scope of sales (should they ever materialise).

I’d spare a place for the high gold to oil ratio as an additional counter argument but it probably says a lot more about the oil markets than bullion prices.

Lots of speculation, then, around gold. Which amounts in the aggregate, I think, to an argument for its exclusive use as a portfolio hedge. Perhaps the key argument against it as a pure investment is that competing asset classes are, at today’s levels, obviously cheap. Some, like corporate bonds, are building up a momentum of positive news flow via Bloomberg et al. But even lowly equities harbour some very interesting prospects. And both can offer capital appreciation as well as a revenue stream - and thereby highlight the opportunity cost of gold.

So why, and this is said with an open mind, would one want it as a major investment class?

*ska fans can hear Desmond Dekker use it here in “It mek”

Photo credit: Joe Lencioni

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