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Can Gold Be Valued After All?

|Includes: GDX, SPDR Gold Trust ETF (GLD)

One of the challenges for value investors who are instinctively concerned about the Fed's money printing policies is justifying the purchase of gold. After all, Warren Buffett has said the following:

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

Buffett is no fan of the shiny metal. So why are other top-notch value investors, including John Paulson and David Einhorn, embracing gold?

Societe GeneraleDylan Grice of Societe Generale may have an answer. He recently published a research report entitled "Popular Delusions: A Minskian roadmap to the next gold mania." Here is an excerpt:

Central bank hoarding of gold in 1970 ushered in the famous gold bull market. With central banks likely to be net gold purchasers in H2 2009 for the first time since 1988 the same starting gun is ringing out today. The price at which the USD would be fully backed by gold (as it was during the peak of the 70s mania) is $6,300. So there is a case for gold being “cheap.” Moreover, the 70s bull market was facilitated by tight energy markets, overly accommodative central banks and nervousness that policymakers had lost their way. Sound familiar?

  • In 1965, concerned at the inflationary policies of the US and the attendant threat to their dollar reserves, the French central bank started converting their dollars into gold. This set in motion events which saw the central banks of Belgium, the Netherlands, Germany, and eventually Britain doing the same in 1970. By 1971, the Bretton-Woods system, by which all currencies were pegged to the dollar and the dollar effectively pegged to gold, had broken. The French had fired the starting gun for the great 1970s bull market in gold and silver.
  • It's worth pointing this out because central banks aren't known for their investment acumen. Some commentators have mockingly suggested that the Reserve Bank of India's recent decision to buy 200m tonnes of IMF gold signals the top of the market in the way that heavy selling by the UK signalled the bottom in 1999.
  • This is cute. But I think it's wrong. Like today, central banks weren't buying gold in the late 1960s to prop it up, they were abandoning attempts to prop up the dollar. Gold feels frothy today, but the Indian purchase of IMF gold eerily parallels the French purchases of the late 1960s. And ill policy winds are blowing in its favour. With the precious metals consultancy GFMS estimating that central banks will be net buyers of gold for the first time since 1988, have the Indians just sounded the same starting gun the French did in 1965?
The Financial Times has more on this subject.

Disclosure: No positions.