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All that glitters is definitely not gold

Buy-and-hold investors in physical gold must be a hardy bunch. The volatility of this once-stable investment has been a roller coaster over the past 20-odd years, with prices reaching the staggering numbers of the early eighties -- $850 (U.S.) an ounce on Jan. 21, 1980 -- and tanking to new lows in 1982 and 1985 (as low as $296 by late June 1982).

A volatile up-and-down history led to the four years from 1998 to 2001, when it couldn't even manage to break through the "floor" $300 barrier. It was only just this year that it did.

Why? Where does this volatility come from? How is it possible that the price of gold could reach such ludicrous heights in the eighties and now be back down to prices not seen since the late seventies? Isn't gold supposed to be stable?

The problem is that people still think that gold has a direct relationship to money. It doesn't. True, the history of this unique metal is practically defined by its use as an exchangeable currency but, in fact, it has had no global connection to the value of currency since 1973 when the world's currencies were "floated" -- that is, countries no longer valued their money by some set amount of actual, physical gold bullion (or promissory notes) hidden in a vault somewhere.

Still, the connection is so deeply entrenched in our minds that gold prices, since the severing of that currency tie, have continued to be a direct result of consumer and investor confidence. When the economy is down, people get out of stocks and into gold. It's safe. It will always be around and people will always need it.

For what? The thousands of years in which gold represented a measure of wealth are over -- we live in a world of "soft wealth" now. Does anyone really believe that all the gold in Fort Knox is worth as much as the code sequences for Microsoft Windows?

Supply and demand arguments have been the hallmark of the gold industry's perceived stability for thousands of years. There are actually two primary sources of gold supply -- mining and central bank vaults. Because of current market prices, most mines are wholly unprofitable; the supply is simply not enough to fill demand.

The remaining gold is provided by the central banks, partly through sales and partly through leasing (estimates are that as much as 20,000 tonnes of gold have been "borrowed" and sold into the market). It is estimated that 30,000 tonnes of gold are still held by central banks worldwide, despite a steady selloff of these reserves. With estimates of annual world gold consumption at 4,000 tonnes, there is simply too much gold being produced to correlate with global demand.

True, the uses of gold go far beyond just pretty things (although about 85 per cent of world gold went to service the jewellery sector in 2001); gold is used extensively in the technology industry and is intrinsic to everything from automobile airbags and transistors to lasers and space-suit helmets. However, this is at best a pittance of the available gold, most of which has been "sold forward" through the next few years. Combined with the poor market conditions for jewellery sales, increased technology in mining techniques and the recent news that China is relaxing its rules on prospecting, the future of gold is hardly shining.

So, when the market tanked in mid-July, gold went right down with it. Unlike May, when terrorist threats drove some investors to the traditional safe haven (gold hit $327.05 on the May 29), they're not being fooled again. This week, when the equity markets dropped below the lows of July -- the Dow was at 7,683.13 on Sept. 24 -- gold couldn't even manage to break through its $327 ceiling ($326.30 on the same day). More telling still, when the Dow gained 158 points on the very next day, gold actually dropped to $322.

Beautiful, versatile and intriguing. Yes, absolutely. A wise investment? Not any more.

Peter Beck is president and a co-founder of Toronto-based Swift Trade Securities Inc.

© The Globe and Mail

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