Gold returns to its role as gauge of tension Barometer rising

Whether or not Western democracies finally take steps to get rid of the threat posed by Saddam Hussein’s Iraq, it is plain that the gold price is back to its old practice of rising whenever there is a threat of large-scale violence in the world.

For much of the period after the United States closed the US$35-per-oz. gold window, the gold price did respond quickly to international tension. In December 1979, the Soviet Union’s invasion of Afghanistan was the event that pushed gold above US$500 per oz. Iraq’s invasion of Kuwait in August 1990 caused the price to spike above US$400.

But in the late 1990s, that relationship broke down and gold shed its role as the “safe haven” at times of geopolitical tension. Horrifying and scandalizing the gold bugs, it became — wait for it — just a commodity.

That did not need to be a surprise. The law of supply and demand works for most things, gold included. The market simply responded to gold’s fundamentals.

Another explanation for gold’s behaviour at times of international tension may also be that the people who are threatened by sudden tides in world affairs will not always be the same people. The gold price actually fell at the time of the Sinai war in October 1973; the August 1991 coup d’tat in the Soviet Union bumped the price a mere US$3.45, and it promptly fell again; the Western bombing of Kosovo and Serbia in March 1999 got only a yawn on the bullion markets. In all those cases, the people most affected by the events were also not buyers of gold.

A third factor was the gold faddism of the late 1970s and early 1980s, which exaggerated the metal’s response to international tension, and also to any shift in market fundamentals. Each bump the United States dollar hit was made out as a sign of imminent currency collapse, presaging hyperinflation and the dreaded day when people would be carrying wheelbarrows of paper money to buy a loaf of bread. (It was always a wheelbarrow, and always a loaf of bread, too; the tale got boring after a while.) The greenback would make a new low against the Swiss franc, and the chorus would come up that no currency was safe — even though the Swiss franc seemed to be doing rather well.

It was probably not fair to expect much different from the generation that had seen the steady prosperity of the 1950s and 1960s hit by 1970s inflation and the oil crisis, but when the apocalyptic vision hit its peak around 1980, the fringe element were already buying canned goods and vacuuming out their bomb shelters, and technical analysts were predicting US$4,000-per-oz. gold. (Nostra culpa — that prediction was quoted approvingly in The Northern Miner.)

When the 1980s came around, and gold production increased drastically, the air came out of the balloon. There were occasional stirrings, but in general gold behaved like the commodity it was. And the development of sophisticated hedging strategies, which relied for their success on a continued downtrend for gold, kept it that way. More than that, the psychology of the gold market magnified bad news and washed away good.

Year-2000 fears were gold faddism writ small, history repeating itself as farce. When the world didn’t end, one time zone at a time, on New Year’s Day, gold soon lost the 3% gain it had made in December 1999.

Much went into changing the fundamentals of the gold market, especially the collapse of world equity markets and the reversal of hedging policies on the part of major gold producers. Gains in gold, and the seeming establishment of a new price trend, changed the psychology drastically. Today, we are seeing the old psychology of the gold market: one in which gold benefits from any lapse of trust in the monetary system, and from any buildup in international tension.

The increased price is welcome, but that is not something for an industry to plan its future on. We would be smart to remember that in the end supply-and-demand fundamentals will rule, and they will rule whether gold is money, or not.