Why gold at $1,000 an ounce could just be the beginning

How significant is gold's break through $1,000 on Tuesday? We have been here before, most recently in February, but each time the yellow metal has failed to hold the line.

By Tom Stevenson
Published: 6:07PM BST 08 Sep 2009

Comments 12

Flagging industrial and jewellery demand has ultimately overwhelmed the gold bugs' desire to push the price through what feels like an important psychological barrier (even if it's really just a round number).

There are some good theoretical reasons why gold could be poised for a meaningful push higher, but none is quite as compelling to me as a bit of anecdotal evidence which will mean more to readers over the age of about 50 than to everyone else.

I had a call at the weekend from my old friend Jim Slater to tell me about a new investment fund he's involved with and which will be managed by his son-in-law, Angelos Damaskos. The Junior Mining fund, as its name suggests, will invest in a portfolio of smaller mining stocks with 70pc initially allocated to gold miners and the rest principally to silver, copper and uranium.

Now, if I'm ever unsure about whether an investment theme has the force with it, the involvement of Jim usually persuades me that something significant is going on. There was a time when he was involved with pretty much any deal of importance in the square mile. Remarkably, he is still active today, in (I'm sure he won't mind me mentioning) his 81st year, and there has not been an investment fashion in the past decade or so that he has not analysed with a laser-like focus and made a bundle of money out of.

He saw, and got out of, the TMT bubble after profiting from the lunatic appetite at the time for so-called incubator funds. He has already made one small fortune from the rise in the gold price over the past eight years through a company called Galahad Gold. Last year he was happily buying corporate debt at distressed prices and now it's gold again.

So what has caught his eye this time round? The advertising blurb sums it up pretty well: "given the current uncertain economic environment, the recent instability of capital markets and the unprecedented amount of money being printed, it is now a good time to invest in gold and base metal mining companies".

I think he is right to worry that the unprecedented monetary stimulus with which the authorities fended off Great Depression 2 is very likely to lead to a serious inflation problem down the track. And that gold and other real assets will be a profitable way of playing that outcome. Having been in short trousers when runaway prices last wreaked havoc with the global economy, I also defer to his first-hand experience.

The credit bubble, as we all know, is being unwound. There are two ways this can happen: either we pay off the debt (that is to say deflate) or we borrow even more (in other words inflate). For an individual, only the first option is available, and a painful period of living frugally is the unavoidable consequence of a bout of profligate spending. For a government, however, especially one that knows that 70pc of economic growth comes from consumer spending, the temptation to adopt the less prudent path is simply too great.

Inflating out of financial crises is what countries have always done and I see no reason why this episode should be any different.

On both sides of the Atlantic the talk is turning to exit strategies and a clear message is emerging. Faced with a choice between moving too soon or too late, governments will prefer to delay. Inflation may return by accident – in a bid to avoid the mistake of the 1930s when policy was tightened too quickly and snuffed out nascent recovery – or it may happen by design because government debts are too astronomic to deal with any other way. But return it surely will.

Gold is one of the principal real assets that investors will turn to in order to protect themselves from an inflationary environment. And the companies that mine the metal are one of the best ways to play a rising price because their profits are so geared to it. As one chief executive of a mining company told Reuters on Tuesday, with gold between $1,000 and $1,500 an ounce "we make more money than we know what to do with".

A rising gold price is not a given and $1,000 may not hold once again. Around half of all demand is for jewellery and at a certain price people will just stop making what is a discretionary purchase. But I suspect we are some way from that point.

Tom Stevenson is an investment commentator for Fidelity International. The views expressed are his own.

http://www.telegraph.co.uk/finance/comm ... -rise.html