As gold prices surge to new highs, it is ironic that has an investment class and a retail commodity the metal can be in demand in both boom and bust. One of the strangest elements of the current economic downturn is the way in which, in its early days, commodity prices surged to record highs. In the case of gold, a typical flight-to-safety investment, this may not seem remarkable.
Yet in the face of complete carnage in the world's most sophisticated financial institutions, and impending doom elsewhere, demand-sensitive commodities such as oil, copper and aluminium all continued to rise, eventually peaking above or close to record levels several months into the crisis. It was as if, for a brief moment, a significant chunk of the global economy was defying gravity and floating on air.
Of course, the moment passed. Commodities soon fell off the cliff like every other demand-driven product. Copper is a good example of the phenomenon: in March last year, it reached a peak of US$4.02 (Dh14.76) a pound, before crashing to $1.30 by the end of the year. The underlying factors behind the bubble were common to several other commodities: a temporary bottleneck in capacity created by strong demand from the construction sector led to gradual price increases which, as they continued their upwards trend, caught the eye of institutional investors.
These investors, it might be added, had seen many of their most profitable asset classes recently go up in smoke. As those investors piled in, the price peaked at a level arguably much higher than it should otherwise have, leading to a significant correction when demand from the real economy began to sag. A similar phenomenon occurred not just in industrial commodities, but also in foodstuffs. A surge in the price of grain and rice led to riots across the globe early last year, the origins of which remain a matter of fierce debate. Bio-ethanol? Speculation?
Either way, as with other asset classes, these soon felt the pinch, too. While following different dynamics to such predominantly industrial and agricultural commodities, gold has also proved itself to be not immune to the slump. Like copper, it reached an all-time peak in March last year of US$1,030.80 an ounce, before falling to a low of $680 in October. Some of this swing had to do with a strengthening over this period in the value of the dollar, whose relative weakness had in many ways led to an artificial overvaluing of all dollar-denominated commodities.
However, gold is more than an inflation hedge: it is also demand-fuelled, used in industrial processes and, of course, retail. In this respect, Dubai is a good example of the double nature of gold. The city is becoming a global centre for gold re-export, with nearly 300 new companies registering with the Dubai Multi Commodities Centre (DMCC) in the past 18 months. The slump in consumer demand that followed the financial crisis hit the retail jewellery market as hard as any. In Dubai, for example, retail demand year-on-year for gold has fallen 40 per cent in the year to July, according to a recent Reuters report.
Similarly, retail demand in Saudi Arabia has dropped 30 per cent in the first half of this year. Given that retail comprises about 90 per cent of the regional market, this is a significant drop. Despite this, however, trading in gold as an asset or hedge has increased over the same period. For example, sharia-compliant gold securities have been available since March, while the volume of gold imports into Dubai increased 13 per cent in the first half of this year, according to the DMCC, reaching $14.7 billion.
On a global scale, this increasing return to gold as an asset has seen the commodity's price recover to $940 an ounce recently. For Dubai's jewellers, a rise in the input cost of gold coupled with continuing low consumer demand prompted by the current economic environment is a double blow they are hoping will begin receding after Ramadan. Yet this is the irony of gold: as both an investment class and a retail commodity, in its various formats it can be in demand in both boom and bust.
The recent resurgence of gold on the commodity markets suggests that some uncertainty about economic recovery remains among individual investors (who are more likely to buy bullion as opposed to the security-based gold products that are favoured by institutional investors). Such uncertainty is echoed in recent losses in equities markets, and a return of dollar weakness. And yet gold's resurgence has coincided with a comeback in other commodities. In London, white sugar reached record levels earlier this month, while cotton and copper futures also hit annual highs.
The coincidence of the two seems contradictory: gold is a safety asset; these other commodities are dependent on fair economic weather. What is the truth? The answer perhaps lies in a repeat of last March's situation. It may not have escaped your attention that many US and British banks have recently posted healthy profits, despite requiring government assistance only months previously. For many of these, their commodities divisions are proving to be valuable assets. The Royal Bank of Scotland, for example, which is partially owned by the British taxpayer, saw its commodity trading profit leap 34 per cent in the first half of this year. According to research by Barclays Capital, inflows into the global commodities market as a whole have grown a record $36bn thus far this year, hitting $210bn.
What, then, can the state of the commodity markets really tell us about the condition of the global economy? Arguably, gold remains the strongest indicator of economic health, with other commodities still too much prey to speculation to be reliable bellwethers. As such, if the money behind gold is going into wearing it, recovery may well be just around the corner. If it is going into keeping it in bank vaults, though, then prepare for more turbulence ahead.
Oliver Cornock is the Regional Editor of the Oxford Business Group