As an investment, the real thing is no more than fool's gold

Investing in gold is an exercise in finding the greater fool around the corner, writes Richard Dean.

Even the most optimistic gold bug knows that the price has little or nothing to do with real demand for its useful properties. Rich-Joseph Facun / The National

The plunging gold price sparked a row with my Indian mother-in-law this week. With the metal falling 20 per cent from its record high in September, she argued, isn't now a good time to invest? I couldn't resist the bait. First, categorically no. And second, there's no such thing as "investing" in gold.

I'll explain why in a minute, but first a word of warning. I have a spectacularly bad track record when it comes to the gold price. I first covered gold when I moved to Dubai as a reporter back in 1998, and I've been telling people to avoid it like the plague ever since.

I cheered the following year when Gordon Brown, then Britain's chancellor of the exchequer, sold most of the country's reserves at less than US$300 an ounce. He raised about £2.3 billion (Dh3.16bn). If he'd kept the bullion, his successor George Osborne could have sold a few weeks ago for nearer £15bn. Osborne described the decision as "one of the worst economic judgements ever made by a chancellor".

So why do I remain so virulently opposed to an asset that has performed so well? Because buying gold for profit isn't investing. It's speculating.

The key thing is that gold has limited real value. Or, in economic jargon, utility. It's pretty and makes nice watches - as I write I'm wearing a gold Rolex that makes me feel 10 feet tall. Gold also has some industrial applications, particularly at Nasa, which uses a thin layer of gold on the visors of astronauts' helmets to protect against solar radiation. You can even eat it: gold has the "E number" E175, the code for food additives.

But even the most optimistic gold bug knows that the price has little or nothing to do with real demand for its useful properties. Speculators buy gold despite its utility value, not because of it. They buy it because they believe someone will be along later who'll pay the same or more. In short, they buy it because they believe the myth will be perpetuated.

Finance has a name for this. It is called the "greater fool" theory, because speculators buy in the hope that a greater fool than them is waiting round the corner. It's often applied to short-term bubbles in which asset prices soar far above their fundamental value: tulips, tech stocks, off-plan apartments. Gold is unique only in that it's endured for so long.

Willem Buiter, the chief economist of Citigroup, has called it a "6,000-year bubble", insisting that he won't personally invest in gold. Charlie Munger, Warren Buffett's right-hand man, is even more hardline. Last year he declared: "I don't see how you become rational hoarding gold. Even if it works, you're a jerk."

At this point it's useful to compare gold with oil. They're similar in that both commodities have rallied sharply since I first landed in Dubai 13 years ago. But they're different in that the oil rally is justified, and sustainable, because of utility.

To be specific, Brent crude has jumped from about $10 a barrel when I arrived to about $100 today. A bubble? No, because oil is incredibly useful. If, as the saying goes, 2.5 billion people in China and India trade in their bicycles for mopeds, demand for oil products will rise sharply in coming decades. So will the price, thanks to a related economic concept: substitution.

Let's think about what we're buying when we buy gold and oil. With gold, we're buying a store of value. That's the benefit. With oil, we're buying mechanical propulsion. There are plenty of ready and willing substitutes as a store of value. US treasuries, Swiss francs, diamonds, Lucky Strike cigarettes - all have acted as a store of value at various times over the past century. Today, many of the world's savers seem to be cottoning on to this, trading in their bangles and bars: scrap gold volumes have more than doubled over the past decade, to about 1,500 tonnes last year, according to the research house GFMS.

Mechanical propulsion, despite the best efforts of hydrogen cell scientists and biofuel farmers, remains dependent on oil and its refined products. There is no effective mass substitute. Plus, we're running out of oil, because it's destroyed in the consumption. Gold is not.

That's not to say I'm urging everyone to rush out and short-sell gold. Will the price rise or fall tomorrow? I haven't a clue. Even Jeff Rhodes, the chief executive of International Assets in Dubai, told my colleagues on the radio last week that the gold market is more volatile than he's seen at any time during his 35 years trading the stuff. From a record high of $1,923 early last month, it fell to $1,535, before closing the month at $1,622.

The long term is just as cloudy. Gold could be $100 an ounce in 20 years if "investors" finally twig that the emperor has no clothes. Or it could rocket to $10,000 if the love affair continues and they seek a haven from the Federal Reserve printing press. Even Mr Munger and Mr Buiter accept that gold may well fly in coming years. The point is, with no fundamentals on which to base forecasts, how can we possibly predict?

My only advice to my mother-in-law is this. Feel free to buy gold for my baby son. One day he'll thank his grandmother for that watch or bracelet or spacesuit. Just don't rely on it for his college fund.

Richard Dean hosts Tonight on Dubai Eye 103.8 FM and is the author of Sink or Swim? How to Stay Afloat in Tough Economic Times: Business Lessons from the UAE.