Gold's Enduring Mystery

By Robert J. Samuelson
Wednesday, December 7, 2005

The price of gold passed $500 an ounce last week, its highest level since the late 1980s. This is an ominous development -- or it isn't. You can make the case that higher gold prices (up 23 percent from 2004's average) warn of worsening inflation. Gold has long served as an inflation hedge, and when U.S. inflation reached double-digit levels in the late 1970s, gold hit a record high of about $850 in early 1980. But you can also argue that the present run-up has little to do with inflation and mostly reflects that old economic standby: the law of supply and demand.

It's precisely because gold has so much history that we still watch its price. In his illuminating book "The Power of Gold," Peter Bernstein notes that "Egyptians were casting gold bars as money as early as 4000 B.C." Later, in Europe, gold enabled kings to pay armies and bribe rivals. In 1511 Spain's King Ferdinand exhorted his conquistadors: "Get gold, humanely if possible, but at all hazards, get gold."

If you'd lived a century ago, gold would have been the basis of your money. Britain dominated the global gold standard; its currency, the pound, was freely convertible into gold. So were many other monies. In the United States, about $610 million of gold coin constituted nearly 30 percent of America's currency in 1900. All the rest -- paper notes and silver -- could be exchanged freely for gold, notes economist Michael Bordo of Rutgers University. But the gold standard's very rigidity led to its collapse in the Great Depression. Too little gold fostered banking and currency crises. On April 5, 1933, President Franklin D. Roosevelt ordered Americans to surrender their gold coins; the country effectively went on a paper-money standard.

Even stripped of its role as money, gold retains an economic mystique. About 85 percent of annual consumption goes for jewelry and, to a much lesser extent, other commercial uses, mainly electronics and dental work. But the recent price run-up seems driven by the remaining 15 percent: investors, speculators and hoarders. These include commodity funds, hedge funds and wealthy individuals. Especially in Asia and the Middle East, the rich hoard gold bars. In the first nine months of 2005, the investment and speculative demand for gold rose 62 percent, reports the World Gold Council, an industry group.

Except for the belief that gold will go higher, just what motivates these buyers isn't clear. Take your pick of anxiety, says analyst Philip Newman of GFMS, a consulting firm: inflation, financial crisis, terrorism, general global disorder. Because holding gold can be an alternative to holding dollars, rising American inflation and a falling dollar on foreign exchange markets are often cited as reasons for higher gold prices. But the dollar has recently strengthened on foreign exchange markets, and the evidence of increasing inflation is thin. True, oil temporarily made it worse. But excluding erratic food and energy prices, inflation has remained at about 2.5 percent since early 2004. Perhaps gold buyers glimpse dangers not apparent in the statistics.

Or maybe the real culprit is true scarcity. Copper is now selling for about $2 a pound, up from about 70 cents four years ago. At $60 a barrel, oil has doubled since late 2003. In each case, global demand -- influenced heavily by China and India -- has squeezed available supplies. Gold could be the same. After the 1980 peak, gold prices went on a two-decade slide that bottomed in 2001 at an average of $271. Low prices discouraged exploration and the opening of new mines. In 2004 global mine production dropped 5 percent, or 128 metric tons, the largest absolute decline in 71 years, according to Newmont Mining Corp., the world's biggest gold producer.

Meanwhile, growing wealth in India, China and the Middle East has revived jewelry demand; that's up 12 percent this year after a 5 percent increase in 2004. Jewelry is often more than adornment; it's also a store of wealth. Consider India. "For thousands of years, [gold jewelry] has been a means of savings," says George Milling-Stanley of the World Gold Council. "Seventy percent or more of consumption is among the rural population. They don't have access to banks, stocks or bonds. They don't trust government or paper currency."

Higher demand collides with constricted supplies; wham, prices rise. That stimulates more speculative demand, but it also enlarges supply by causing past investors in bars or jewelry to sell and take profits. Governments also have large gold stocks; their sales and purchases influence prices, too.

Though new mines often require a decade to bring into production, supply could ultimately overtake demand. Or prosperity in India and China might multiply by many times the world's gold bugs. They may regard gold as a more trustworthy form of saving than any currency, even though gold investments don't pay interest or dividends. Whatever happens, the fears and anxieties that give gold its speculative appeal could intensify or dissipate. Gold is an unending mystery, because its value lies less in what it does for us (unlike sugar, copper or oil) and more in what it symbolizes. It is almost as unfathomable as the human drama itself.

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