John Webster, in his book Metallographia, writes: “Natures ultimate labour is in time to bring all Metals to the perfection of Gold: which she would accomplish, if they were not unripe and untimely taken forth of the bowels of the Earth.”

Gold is considered the perfect metal, and all other metals are thought to gradually mature in the ground until they eventually reached the perfection of gold. There are solar references to gold in chemical texts where the obvious connection is the brilliant colour of each. Just as the Sun is unique in our solar system, gold has properties that make it quite distinct from the other known metals. Most metals appear different over time: iron rusts; a white crust covers lead; silver becomes black; copper turns green. But gold is chemically inert, so retains its brilliance in eternal glory.

The oldest known gold objects are 7,000 years old when early Egyptians used them as decoration. Eventually gold was recognized for its ductile qualities by the Egyptians to replace rotten teeth, a practice that continues even today. Gold was first used as money when the Egyptian pharaohs introduced a half-ounce gold wafer as a medium of payment. The first gold coins minted in China date to around 600 BC. When commodities compete for the role of money, the one that loses the least value over time takes on the role. Gold is found on every continent except Antarctica, where mining is prohibited, with operations ranging from minuscule to enormous.

Gold can mean different things to different people—a financial asset, a store of value, a medium of exchange, an insurance against global uncertainty, and even a “barbarous relic” in the words of economist John Maynard Keynes (although it is more likely that he was referring to the constraints of the gold standard at the time). All of this means one thing: finding a valuation method acceptable to all is a fool’s errand; and the value of gold is more likely to be determined depending on the individual’s perception of gold.

Jewellery has historically accounted for over half of the annual physical gold demand. Around 10% is used for industrial purposes, including dentistry and electronics, and the rest is bought for investment and used by central banks for reserve diversification. Gold’s use as an investment emanates from its role as a safe haven. Its role has been recognized as an effective portfolio diversifier due to the lack of correlation of the gold price with traditional investments and as a currency and inflation hedge.

The post-Covid-19 era of ultra-loose money and negative real bond yields has burnished the lustre of gold. Its prices have risen about 25% this year, cementing its position as one of the best-performing major asset classes of 2020 as investors looked for safe avenues to park their cash at a time of heightened uncertainty. The precious metal recently traded at $1,981 an ounce—its highest ever—crossing the all-time peak of $1,921 scaled in 2011. This rally is driven by buyers of bars, coins, and exchange-traded funds (ETFs). Global holdings in gold-backed ETFs hit a new all-time high thus offsetting a collapse in jewellery demand.

Like the metal itself, reasons to buy gold are also malleable. Jewellery retailing has been hindered by the closure of shops and postponements of weddings—a key trigger for purchases especially in India. Given jewellery is the largest component of steady demand, a soaring gold price may indicate bling losing its zing, thus predicting a price drop. Demand for gold as an investment had outstripped that for jewellery manufacturing only thrice in the past decade which ended last quarter—this portends an ominous bubble building up.

The best reason to question gold’s rally is that it is hard to find bearish commentators these days and bulls still have many reasons to hoard the metal. Gold, primarily traded in dollars, performs well when real U.S. interest rates fall. Since 2006, for every 1% decline in real U.S. Treasury yields, gold prices have increased by about a fifth. The central banks’ efforts in debasement of fiat currencies, coupled with global instability, also encourage gold bugs to press the buy button. If history is any guide, the current real annual gold returns of 20%-25% are once again approaching the 2008-11 bull run. We still have vivid memory of what happened next—retail buyers besieged bullion dealers and gold prices crashed.

The current rally is young—less than two years old and the metal’s prices have risen in August in 15 of the last 20 years. But once lockdowns are lifted in phases and economies continue to show signs of sustained recovery, expect gold to lose its shine and some of its perfection.

Views are personal. The author is a Harvard alumnus and works for an investment bank in Mumbai. He is also a member of the Young Scholars Initiative at the Institute for New Economic Thinking, founded by George Soros et al.

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