The return of gold

By all mainstream accounts of the global economy, the year 2003 marked a turnaround. The United States economy posted a rise in GDP of 8.2 per cent in the July to September quarter, the long-suffering Japanese economy saw a return to growth and business confidence improved even in sclerotic Europe.

The Asian economies grew at a sizzling pace. But if the world economy is going to do so well, why is gold, the traditional safe haven, such a favourite with investors?

Why has the price of gold risen by 20 per cent in 2003, and why is it poised to breach an eight-year high? The bull run in gold stocks sits uneasily alongside the bull run in equities, or the rise in commodity prices.

Gold is also an unlikely candidate for investment, because there are no dividends or interest to be earned from it.

Central banks had proclaimed they no longer had any use for the yellow metal, and gold has severely underperformed other asset classes for the last few years. The precious metal is still priced at almost half its 1984 peak of over $800 an ounce.

Yet, since September 2001, gold has risen around 60 per cent against the dollar. The date could be a pointer to the reason for the rise, and there's no doubt that the so-called War on Terror has been a big reason for the return of gold.

The steep climb in the metal's prices prior to the Iraq war proves that point. At the same time, it's worth noting that although gold prices fell after the Iraq campaign, that fall has been more than made up since, and it is unlikely that the Iraq quagmire is responsible.

Simply put, gold has gained in lustre with every drop in the value of the dollar against other currencies. Gold is, after all, as much an international currency as the dollar.

But there's another, more fundamental reason for the added sheen on gold. That reason lies in the reflation policy pursued by the world's central banks, which have released a flood of money into the markets and lowered interest rates dramatically.

This policy has allowed US consumers to continue to splurge, resulting in a consumption and mortgage boom that has buoyed the economy.

At the same time, it has led to record current account deficits in the US, and a severe imbalance in the global economy. Those investors who feel that the current boom is unsustainable will naturally turn to gold.

There are also other reasons for the bullishness ""for instance, gold consumption is believed to have exceeded new production of gold in the last few years. Also, during the bear years, producers used to sell their gold forward to hedge against lower prices.

That trade has stopped after several producers lost a lot of money. And central banks have not sold their reserves for some time. But apart from these superficial reasons, there's a real message that the rising gold prices are conveying to the world "" the dollar will have to fall much more before global economic imbalances are redressed.