Though gold has given up some of its gains over the past few days, the US$2000 per ounce mark beckons. After touching $1477 per ounce at the end of June, the precious metal has since shot up to reach a high of $1920, from which it has retreated somewhat to its current level of $1860. Looking back over a longer period, gold’s ascent is more impressive. It is up 170% from its October 2008 lows of $677. From its 1999 nadir at $250 – its lowest point after hitting $895 in 1980 – gold has risen 636%, handily beating investment grade government bonds and common stocks over that twelve year period.

Given this meteoric rise, it’s no surprise that talk of a bubble in gold has gained momentum.This chart compares gold’s climb to that of the Japanese Nikkei stock index in the 1980’s, the Nasdaq Composite Index in the 1990’s, and more recently, that of the Chinese and oil markets. Admittedly, gold’s price move does look eerily similar to these previous mania sequences.

But is this enough to conclude that gold is in a bubble? Not necessarily. For one thing, that chart merely plots nominal prices. Adjusted for inflation, the January 1980 high of $895 is equivalent to $2600 today. So, in real terms, gold still has a ways to go before it even matches its earlier performance.

One must also go beyond the price movements depicted on chart patterns and consider the fundamentals. Now those who are negative on gold typically argue that the yellow metal has no intrinsic value. As they see it, gold is just shiny stuff that is costly to store, while generating no interest or dividends. Underlying this assertion is the idea that value is objective, that things have worth only to the extent that these possess qualities that compel all thoughtful observers to acknowledge them as valuable. But value is subjective. A thing only has worth to the extent that human beings choose to lend it value. To someone willing to sacrifice for the future, the interest attached to a bond or the dividends tied to a stock will render those securities valuable. But interest and dividends will mean much less to someone who lives entirely in the present.

So it is with gold. There is nothing about its material elements, in and of themselves, that make gold worth a certain number of US dollars per ounce. Aside from its ornamental and status signalling uses, its value has historically come from people deeming its rarity, portability, divisibility, and durability to be such as to make it a highly suitable medium of exchange and a store of wealth. In this respect, gold has always competed against other objects and the chief substitute for it in our time is, of course, government issued . Insofar as people lose confidence in the latter, one can expect that demand for the former will rise.

And that is precisely what is happening. In part, the growing distrust of fiat currency fits the traditional story line of gold being a hedge against inflation. We see this, for example, in the way that the gold price goes up in accord with expectations that the Fed will embark on a third round of quantitative easing (QE3).

Yet the prospect that governments will cheapen their monies in a desperate attempt to revive the economy and pay off the huge public debt is not the only factor driving the price of gold. Yields on long-term bonds issued by countries like the United States, Germany, and the United Kingdom have fallen significantly. This actually suggests the prospect of deflation.

Not all government bonds yields, however, are declining — only those of countries deemed least risky. More telling still, is that the other traditional safe havens are being abandoned, most notably the lending of money to banks (especially European ones) whether by deposits or repurchase agreements. If we remember that banks play a critical role in generating the money supply, this loss of confidence is, for all intents and purposes, equivalent to a growing suspicion of fiat money.

The last major gold rally ended when Paul Volcker, as head of the US Federal Reserve, came to the defence of the fiat system by tightening the money supply and driving up interest rates into the high teens. Until governments once again come to the rescue of the current monetary regime with a solid plan of action, gold’s climb will continue to make perfect sense.

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