Gold's 30% Surge Puzzles Bernanke: William Pesek

Alan Greenspan had his conundrum. Now, Ben Bernanke has his enigma.

The behavior of long-term interest rates had the former Federal Reserve chairman scratching his head. It’s gold that puzzles the current Fed chief. Damned if Bernanke and his fellow central bankers can explain the surge by a metal John Maynard Keynes once dismissed as a “barbaric relic.”

“I don’t fully understand movements in the gold price,” Bernanke said on Capitol Hill last week.

That shocks gold bulls like Johann Santer, managing director at Superfund Financial in Tokyo. And it may be awful news for the global economy that some investors are surer than ever that the gold rally is just getting started.

It’s hard to decide what’s more frightening: that investors are losing confidence in paper money or that the shepherds of the world’s major currencies don’t get what’s going on. Gold’s climb of almost 30 percent in a year reflects fear, not just market concern over inflation or deflation risks. People have lost trust in the global financial system.

As Lehman Brothers Holdings Inc. was crashing in September 2008, Superfund was loading up on gold. At the time, Santer got his share of giggles and rolled eyeballs for predicting gold would rise to $1,500 an ounce over the next two or three years. With gold around $1,230 an ounce, no one’s laughing anymore.

‘Black Swans’

There are many reasons why gold is back in vogue, yet two in particular are worth considering. One is fear about “black swans,” unexpected events that have great impact. The second reflects how little gold many central banks in Asia and elsewhere hold on their balance sheets.

A year ago, the idea of gold hoarding struck me as odd. It was hard not to view fans of the precious metal as akin to people standing on street corners with megaphones predicting apocalypse. The world economy seemed to be on the mend, a sense of order was returning to markets and doomsayers like Nouriel Roubini were getting fewer headlines.

Greece’s unraveling was a sobering reality check. It wasn’t that a fiscally irresponsible economy smaller than Iran’s was stumbling. It was how, as in the case of Iceland before it, Greece was cast in the role of canary in the financial coalmine. European banking shares suggest a Greek debt default may be just a matter of time.

Contagion’s Return

It was suddenly clear that the contagion that emanated from the U.S. in 2008 had never really gone away. Greece’s troubles cast a huge shadow over far more important economies, like Spain’s. The idea that the 10th biggest economy, one bigger than Canada’s, might someday renege on debt put an end to hopes for a smooth 2010.

Perhaps the best explanation of these all-too-tangible risks comes from Anthony Crescenzi, a strategist at Pacific Investment Management Co., the world’s largest bond-fund manager. The question is this: As the U.S. is aggressively backing its financial system, who is backing the U.S.?

Thinking back to the darkest days of 2008, few will quibble with government efforts to stave off Armageddon. The promise was that if investors tolerated a surge in debt issuance, capitalism and prosperity would be saved. As fear is returning to the global economy, the worry is that industrialized nations are out of ammunition.

‘Keynesian Endpoint’

Have nations reached a “Keynesian endpoint” as exhausted balance sheets leave policy makers with few options to bolster growth? We’ve known for years that the Group of Seven nations were losing their ability to guide markets. Now, they’re losing hope of shielding economies from them.

As all hell threatens to break lose anew, are you going to buy stocks? Probably not. Bonds at a time when no one trusts credit ratings? Doubtful. Euro? Nope. Yen? Risky. Dollar? For many, the U.S. currency is the least ugly contestant in this financial beauty contest.

A question here is what central banks do. Many are sitting on too many dollars for comfort and upping gold reserves may be the diversification move of choice.

“I believe the biggest customer base will be Asia,” says Santer. “And if Ben Bernanke doesn’t see why then we have even more reason to worry about the global economy.”

Gold Grab

South Korea, for example, is the 15th biggest economy and gold accounts for just 0.2 percent of its total reserves. If markets remain volatile and the dollar gyrates, it may be among the Asian nations that move to buy more of the metal.

In November, India surprised markets with a $6.7 billion purchase from the International Monetary Fund’s bullion stash. India’s gold grab was the vanguard of central banks more aggressively diversifying reserves away from U.S. assets.

It’s not what the Greenspans of the world envisioned 15 years ago. Back then, warehousing gold bars seemed a bit retrograde. Central banks had gotten so good at whipping inflation that paper money was just fine. Fort Knox was no longer needed.

The post-Lehman world is dispelling such notions and we may be on the cusp of history’s greatest gold rush. Bernanke and his peers would be wise to contemplate why.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net

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