An elderly gentleman empties a bag onto the counter. Out tumbles a pile of gold jewelry and crumpled paper notes – offers from downtown traders for his late mother’s heirlooms. Reiner Bianchi, goldsmith of one of Munich’s largest precious metal trading houses, readies himself with eyeglass, acid and electronic scale to assess the value.
The trading house, which annually turns over €500 million ($650 million) in bars, ingots and coins, is doing a brisk business. It is not alone. The futures exchange Comex, which handles most of the precious metal’s visible derivatives trading, noted a record volume of 659,000 contracts of 100 ounces each on 10 November 2010. But this is only the tip of the iceberg.
Experts estimate that up to five times as much gold is traded between banks and brokers over the counter. It’s a specialist business with only a handful of insiders in the German market. Global demand is skyrocketing, and hedge funds, their purses bulging with $2.1 trillion according to figures from the US-based Hedge Fund Research Institute, are buying. High-profile investors like Jim Rogers and John Paulson are also buying, as are rapidly increasing numbers of retail customers.
According to the statistics of the World Gold Council (WGC), which represents 60% of the world’s gold-mining companies, the percentage of the mines’ output that ended up in the hands of investors rose from 4% a decade ago to over 38% in 2010. Last year, investors paid $59.6 billion for 1,516 metric tons of gold bars, coins and exchange-traded products. In the first six months of 2011 alone, they spent another $30.7 billion.
Due to overwhelming demand, several banks and dealers ran out of gold during the summer months of 2011. Vaults from Singapore to London have now been restocked and banks as well as the 110-year-old Perth Mint are increasing warehouse space. By contrast, only €15 million ($20 million) worth of precious metal ingots are held in the Munich trading houses’s vault. “We still have space to spare and would be happy to rent it out,” says Mirko Schmidt, one of the company’s two ex-banker founders.
The current volumes contain an element of hype that is going to cool down Mirco Schmidt What is the reason for the sudden interest in a metal that had been out of favor since the dot-com boom? Jürgen Birner, sales director at the Munich firm, is convinced it is because “investors want to preserve their purchasing power.”
Having predicted the current gold rush in 1999, when gold was trading at $255 per ounce (today it is $1,590), he knows what he is talking about. The first buying wave hit the company in the aftermath of the Lehman Brothers bankruptcy. The next spike followed the Greek debt crisis. The downgrading of Italy’s credit rating saw queues of customers winding around the block.
The lack of trust in currencies and a growing fear of inflation are leading ever more investors to seek a safe haven. The February 2010 WGC study
shows that every percent of growth of the money supply M3 in the US is followed by a 0.9% rise in gold prices. “The impact of the European sovereign debt crisis, the downgrading of US debt, inflationary pressure and the still-fragile outlook for economic growth in the West are likely to drive high levels of investment demand for the future,” the council writes. Linking Global Money Supply to Gold and to Future Inflation
Ironically, the $2.3 trillion that the US government has printed in the last two years has not only vastly increased the threat of inflation – at 0.25% interest, this cheap money also handed investors the ability to effectively hedge against printed money by purchasing precious metals.
So are we in a gold bubble? “The current volumes contain an element of hype that is going to cool down,” says Mirko Schmidt. However, he and his colleague do not predict that the boom will end until 2013 or 2014, when, in their opinion, the US economy will stabilize.
Central Banks Go Gold
Even the International Monetary Fund (IMF), which does not print money, followed the US about-turn on gold in 1971. While the Bretton Woods Agreement compelled member countries to pay 25% of initial subscriptions and demanded interest payments for loans in gold, it reversed the practice in 1976.
The IMF now claims gold reserves may destabilize currencies of members, but it finds itself increasingly isolated in that view. After many years of selling off their reserves, central banks around the world are buying gold again. According to the WGC, they purchased a total of 200 tons in the first half of 2011 alone.
In contrast to the attitude of the IMF, the German Bundesbank refers to its 3,401 metric tons of gold reserves (the second-largest hoard in the world) and points to the confidence that it “instills in the currency.” It is something the euro could do with more of.
Numismatic coints, formerly the field of eccentric experts, are also in demand in Munich, where they attract interest from as far afield as Russia. And for good reason: collectors’ coins were excluded from the 40-year ban on privately owned gold in the United States during the 20th century.
In 1933, President Franklin D. Roosevelt confiscated all private gold holdings – with the exception of numismatic coins – of US citizens in return for $20.67 an ounce in paper money. When the price subsequently soared to $35 an ounce, it was the Treasury, not the original owners, who pocketed the difference.
European governments have acted similarly in times of crisis and war, and Birner thinks private holdings may again prove desirable to cash- strapped governments. Even today, a rare double eagle gold coin, ordered melted down in the 1930s and believed to be worth millions, is being fought over in court by its owner and the US government.
Gold, of course, is the original money. King Croesus of Lydia reportedly coined the first gold coins in 564 BC. Even in Roman times governments tended to live above their means. Emperor Nero, for example, diluted the gold and silver in coins to fund bread and circuses from near-empty state coffers. His successors continued the practice, though eventually merchants refused to accept Roman coins and resorted to barter trade instead.
It took Rome 200 years to reduce the purchasing power of the denarius by 95% of its value. The US managed it in less than 80 years, with most of the devaluation occurring after President Richard Nixon defaulted on the Bretton Woods Agreement in 1971. The US dollar became the reference currency for the world in 1944, precisely because no other country held such vast gold reserves (which the WGC estimates at 8,133 tons today).
The Bretton Woods Agreement, created in 1944, guaranteed that the US government would take back every single dollar and exchange it for gold at the rate of $35 an ounce. The financing of the Vietnam War, however, meant the government printed far more money than could be repaid from the reserves in Fort Knox. Nevertheless, rather than stop spending, the administration simply created ever more money out of thin air.
In 1900, a dollar bought about 14 loaves of bread. Today, it is unlikely to even purchase a stale one. By comparison, one ounce of gold has always bought a decent suit. And while the world has seen many currencies come and go, almost all of 168,000 metric tons of gold ever mined is still around.
At current prices, all the gold in the world would not pay back the US debt of around $15 trillion, although Mike Maloney, founder of the online precious-metal dealership
GoldSilver.com, argued in a recent newsletter that historically the gold price always rises until it covers all currencies printed. In other words: the current price of gold actually says less about the value of gold than about the currencies by which it is measured.
Back in Munich, Reiner Bianchi assesses the possessions of the elderly gentleman. Unfortunately, his late mother may have been less thorough with her acquisitions than her son is with selling them. “This is a fake,” says the goldsmith as he examines a golden Omega replica watch. The elderly seller consults his notes. “But I was offered €800 for it,” he protests. Bianchi turns the watch around. The seemingly elegant item has an over-dimensional casing, he points out.
Bianchi advises his customer to accept the competition’s offer. The rest comes to more than €16,000 ($20,700), almost €3,000 more than offered downtown. The man leaves a happy customer.