06/24/10 Stockholm, Sweden – A recent article by Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management, predicts a possible 70 percent decline in the value of gold… just like what was seen in the 1980s. Eric Janszen of iTulip persuasively argues against his logic by describing how it’s the role of central banks to show confidence in flawed fiat currencies — especially the reserve US dollar — while hedging against inherent weaknesses in paper money with gold, which is dismissed as out-of-date… and yet still hoarded in massive quantities on government balance sheets.
Here’s what Sharma wrote in the Times of India:
“The daily turnover in gold ETFs — now at $3-$4 billion a day — is up nearly 10-fold from levels of three years ago. Investment demand currently represents the largest component of overall demand for gold compared with a mere 4% just a decade ago. Some gold bugs are throwing about very aggressive price targets of $2,000 or $3,000 an ounce, from levels of just over $1,200 an ounce now.
“If the yellow metal does reach those levels, it would form a bubble of epic proportions. Gold’s peak at $850 an ounce in 1980 marked one of the biggest bubbles in post WWII history and the yellow metal then fell by more than 70% in the following two decades as real interest rates rose and the global economic environment improved significantly. At $1,800 an ounce in current dollar terms, gold would be at the same level as at the absolute peak in 1980.”
Janszen allows for the fact that Sharma is quoting some statistics that are indeed related to gold. However, they are not what he views as the key drivers of gold’s current price level and trajectory.
According to Eric Janszen of iTulip:
“The author makes a number of valid points, such as the high level of money flows into gold ETFs, but he misses the single most important contributor to the extraordinary event of gold’s continuous nine year rise, and it’s not gold bugs. He, like most analysts, does not understand the role gold plays as a sovereign global financial asset and currency.
“Gold hedges currency risk, and currency risk is rising. Gold hedges the second order effect of bad fiscal policy, a weak currency…
“…The U.S. government has over the past ten years financed two seriously expensive bread and circus events, first the technology stock bubble, second the housing bubble. They first allowed asset inflation to get out of control and then, after the bubbles collapsed, dipped into the public till to bribe the public with their own money to keep quiet about it. Ten years after the tech bubble popped, the NASDAQ remains 50% below its peak. Ten years from now, so will housing…”
As he points out, it’s difficult to argue gold is only a commodity when it’s the single metal owned — and perceived as a monetary instrument of value — by central banks themselves. As Janszen writes, they “don’t own silver, or platinum, or copper, or lead, or aluminum, or zinc, or nickel, or any other metal for that matter.” Instead, what they do own is 30,000 metric tons of gold. Essentially, its value as a nation-less currency is best proved by the fact that most nations would like to hold it in their reserves.
The piece makes for a compelling read, and can be found at iTulip’s response to how gold could decline 50% before the World Cup is over.
Best,
Rocky Vega,
The Daily Reckoning
Rocky Vega
Rocky Vega is publisher of The Daily Reckoning. Previously, he was founding publisher of UrbanTurf and RFID Update, which he operated from Brazil, Chile, and Puerto Rico, and associate publisher of FierceFinance. He specialized in direct marketing at MBI, facilitated MIT Sloan School of Management programs, and has been featured on CBS. Vega graduated with honors from Harvard University, where he was on the board of Let’s Go Publications and directed business programs involving McKinsey, Goldman Sachs, and Harvard Business School faculty. He is also enrolled at the Stockholm School of Economics.
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