Column

FLIGHT OF THE GOLD BUGS

The precious metal is back in vogue, but for the wrong reasons

DONALD COXE July 12 2004
Column

FLIGHT OF THE GOLD BUGS

The precious metal is back in vogue, but for the wrong reasons

DONALD COXE July 12 2004

FLIGHT OF THE GOLD BUGS

The precious metal is back in vogue, but for the wrong reasons

Column

DONALD COXE

THIS IS THE YEAR of the cicada. In the eastern U.S., they’re coming back in the billions to do the three things they’ve waited 17 years for: dating, mating and procreating. The first is done so noisily that backyard human conversations can be drowned out by thousands of homopterous invitations. Other bugs of that era are also re-emerging: gold bugs, those who believe that all paper money is doomed to worthlessness. In 1987, gold lovers were ubiquitous, shrieking that inflation lurked dangerously as the precious metal hit US$500 per ounce, up 55 per cent from the previous year. But inflation didn’t

return. And it wouldn’t, for 17 years.

Today, there’s talk of inflation even among the see-no-inflation-evil Wall Street economists, from whom rarely was heard a discouraging word for all those years. That was the period of disinflation, which meant falling interest rates most of the time and rising stock prices, also for most of the time. Those 17 years also coincided with the reign of Alan Greenspan, who became Fed chairman on Aug. 11,1987, and has just been sworn in for his fifth four-year term. To hear these re-emergent gold bugs, he shudda quit while he was ahead. The fear of inflation is back.

Unlike the cicadas, few gold bugs have survived. They’ve been called from their crypts like so many Iolanthes by the call of “Four Hundred and Forty!”—

US$400 gold and US$40 oil.

(Not that these two numbers are entwined: gold was trading above US$400 an ounce when oil was still in the low US$30s; but the fact that those two magical threshold numbers popped up, however briefly this spring, was apparently enough to end the bugs’ 17-year exile.)

To listen to the gold bugs, the return of their kind of inflation (the Bram Stokerish stock market-crashing kind) is guaranteed by that big price tag for oil. They point to the big rise in oil prices back in 1973-1974 that triggered 14 per cent inflation. However, that cavalier approach to history ignores that oil prices more than doubled back then compared to a one-third rise now, and inflation now is about one-fifth of what it was then.

The gold bugs would no doubt argue that today’s costly oil may not yet have worked

its way fully into the inflation numbers. Oil prices have been above US$33 for only six months, and it takes time for businesses to raise their own prices to pass along those increases. If the economy stays strong, and if they aren’t competing with Asian powerhouses, businesses will doubtless try to recover those cost increases.

Yes, the good news on inflation is behind us, and there’s doubtless worse news ahead. But that may not be the reason for gold’s recent strength. A new, possibly dangerous connection with oil may be forming. In fact, oil and gold moved up together in May. Oil’s move was powerful and was of front-page proportions. It was Topic A, and even became a political issue in the U.S. Gold’s increase, on the other hand, was a small, barely ob-

served bounce from US$375 to US$393. It’s currently trading in the US$390s, although oil has pulled back to the high US$30s.

What made that gold uptick interesting was that it coincided with a sudden weakening in the value of the American dollar. The greenback had been in a two-year bear market beginning in February 2002, but it rallied this February against all major currencies until mid-May. That rally coincided with the release of powerful U.S. economic performance statistics (particularly the blowout nonfarm payroll report for April, which confirmed the job-gain trend), and with

softening economic reports from Europe, China and Australia. The strong numbers convinced almost everybody that the U.S. was once again on a roll, which meant the Fed would have to start raising interest rates fast. Result: a strong dollar and weak gold.

With oil prices touching the much-discussed US$40 a barrel at the same time, the dollar weakened. That’s the real reason why gold stopped falling and started rising anew. What was unfolding was a new concern among some economists and strategists. They watched evidence of faltering sales of American-made SUVs, and reflected that such success as Detroit has shown in recent years has come from SUVs. Japan is already selling hybrids that get up to three times the mileage of a Jeep or an Expedition. Is another Detroit disaster looming? Bad news for the struggling automobile industry is sobering news for the economy.

Wal-Mart got attention at the same time when it expressed fears that its customers would be hurt by high gas prices. The people hurt most are those who drive to work, the suburbanites, the backbone of the American economy. Within days, some leading U.S. economists announced cutbacks in their forecasts for growth. The dollar responded by sliding further. Gold rallied, even though a weakening economy means weakening inflationary pressures.

So oil and gold are linked. If over-indebted consumers cut back their discretionary spending because of high gas prices, that’s really bad for the buck—which means it’s good for gold.

The gold bugs are thrilled their precious (metal) is back in vogue. But they remain on the wrong track. Gold is more likely tied to the disinflationary impact of oil prices than to any inflationary effect.

It’s tough being a bug.

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments. dcoxe@macleans.ca

THE GOOD NEWS on inflation is

behind us, and there’s doubtless worse news ahead. The prospect of rising U.S. interest rates could mean a strong dollar and weak gold.