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Gold bars from melted gold jewellery and pure gold bars are seen at Express Gold in Toronto (Moe Doiron/Moe Doiron/The Globe and Mail)
Gold bars from melted gold jewellery and pure gold bars are seen at Express Gold in Toronto (Moe Doiron/Moe Doiron/The Globe and Mail)

The case against gold Add to ...

No doubt about it, gold is a hot investment these days. But its soaring popularity hasn't persuaded Tim McElvaine that now is a great time to join the bull market in bullion. Quite the opposite, in fact.

"Today's fad is tomorrow's flop," he said from Vancouver, where he runs McElvaine Investment Management, a money management firm. "I'm as confused as the next guy about what's going to happen with currencies and whether [Federal Reserve chairman]Ben Bernanke is right or wrong. But I'm not sure a whole bunch of yellow stuff in a warehouse is going to do much."

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Mr. McElvaine is a lonely figure these days - a bear on gold. Driven by fears of inflation and potential currency devaluations, investors have propelled the yellow metal to $1,400 (U.S.) an ounce, a remarkable climb from under $300 near the start of the decade. Now, with the price of gold hovering near a record high in nominal terms - though still below its 1980 peak when adjusted for U.S. inflation - the bulls see plenty more gains ahead.

In the middle of this market fever, it is easy to forget that gold still must obey the law of supply and demand - and that the underlying fundamentals are now looking distinctly negative for the metal's long-term prospects.

The jewellery factor

Unlike most commodities, gold isn't consumed in high quantities. Industrial uses account for only about 10 per cent of total demand, which is why jewellery makers have traditionally provided most of the market for the metal.

However, global demand for gold jewellery has been in steady decline, replaced only by demand from fickle investors - a shift that could have a disastrous impact on the price of gold if those buyers turn squeamish.

According to GFMS, the London-based precious metals consultancy, global jewellery purchases plunged to 1,759 tonnes last year from more than 3,000 tonnes at the start of the decade, as the rising price of gold turned off consumers and jewellery makers cut back on gold content.

"For many markets, we've seen jewellery demand suffer quite noticeably," said Neil Meader, research director at GFMS. While jewellery demand in China continues to increase, the Indian market is down. So is demand in the United States - the world's No. 3 market - where gold sales to jewellers have plummeted about 50 per cent over the past four years.

At the same time as demand is falling, gold supply is rising. Most central banks, for instance, are jettisoning their gold holdings. According to the World Gold Council, total gold holdings were about 30,600 tonnes in December, down nearly 2,900 tonnes since the start of the decade - and these overall declines take into account an increase in gold holdings by China's central bank.

Adding to supply is ramped-up production from mines. This rose to a four-year high of 2,572 tonnes in 2009. In addition, consumers are now happily mailing in their "scrap" gold jewellery to the host of gold-dealing companies that have sprouted up in recent years. Add in this recycled gold and total world supply hit 4,034 tonnes last year, the highest level in at least a decade.

The fear factor

Of course, gold is still in high demand. But the source of this demand is now investors, who have become gold's biggest buyers for the first time in about 30 years. These buyers have no uses for gold, other than the hope of selling it to someone else at a higher price somewhere down the road.

"We talk about a secular upward shift in the investment demand for gold," said Jeffrey Christian, managing director of CPM Group, a New York-based commodities research and advisory firm. "More investors have been buying more gold at higher prices over the last 10 years than ever before in history."

The bullish argument for gold rests primarily upon fear - the fear that paper currencies are being devalued by governments and central banks; the fear that the world is awash in money, which will lead to problematic inflation; and the more general fear that the world is falling apart, and prudent doomsayers will need more than shotguns and tins of beans to survive.

There is nothing new about these fears. But in recent years, they have gained heft as terrorist attacks, stock market collapses, Wall Street implosions and creative monetary policies have rattled investors' confidence in paper currency.

As investors grow more fearful, gold has become increasingly easy to buy. In Abu Dhabi, Berlin and Madrid, passersby can purchase the metal at vending machines, called Gold-To-Go.

The most profound impact on the market, though, has come from exchange-traded funds (ETFs) that hold gold. The SPDR Gold Trust, launched in 2004, now holds nearly 1,300 tonnes of gold worth about $58-billion - a considerably larger gold holding than Switzerland's central bank.

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