Gulf-Related Gilt Trip: Gold Falls as Peace Chances Rise

Disaster potentially averted in the Persian Gulf is translating into disaster found for the long-moribund gold market, which staged a brief rally last week only to nose-dive after Iraq’s first peaceful overtures.

Gold prices on the New York Commodities Exchange continued to slide Tuesday, losing $3.30 an ounce to close at $385. The metal’s value plummeted Monday by $27.

Silver prices also continued to drop, falling 0.8 cents to $4.84 an ounce. Silver prices were off 33.9 cents Monday.

The massive drop this week reflected investors’ belief that there is now less chance of a war between the United States and Iraq, traders said Tuesday. In the past several days, Iraqi President Saddam Hussein has indicated a willingness to negotiate a peaceful settlement to the Persian Gulf crisis and has promised to release all women and children hostages held in Iraq and Kuwait.

“The war premium has been blown,” said John Nadler, vice president of precious metals trading at Bank of America in San Francisco. “We have more or less returned to the levels we saw prior to the Gulf crisis.”

Indeed, the illusions of precious-metal traders--who expect the value of gold to soar in times of political and economic unrest--are being shattered. Gold is trading for a mere $10 more than its price before Iraq invaded Kuwait. (Silver tends to trade in tandem with gold, but its value is sometimes depressed by an abundant supply.)

Worse still, gold is worth less today than it was five years ago, making it one of the worst investments of the decade.

Although the Dow Jones industrial average has fallen nearly 400 points from its high this year, it is still up nearly 38% from 1986. Gold, meanwhile, is worth about $10 an ounce less than it was in 1986.

Moreover, stock investors often earned dividends on their investments, while gold investors generally had to pay someone to hold their ever-depreciating bullion.

In addition, it is often costly to trade gold, particularly when it comes as gold coins. Typically, investors pay 2% to 3% more for gold bullion than they would be able to sell it for on the same day, traders said. However, this so-called spread on gold coins can be higher, depending on the market and the type of coin purchased. That adds further risk to an already volatile investment.

Nevertheless, gold traders note that the metal has occasionally provided gratifying returns. In 1980, for example, gold soared to $850 an ounce from about $250 in 1978.

And those who purchased “numismatic” gold coins--those that are rare enough to have additional value for collectors--have found their investment will appreciate by 20% to 25% this year, regardless of the Persian Gulf situation, said Keith Zaner. He is trends editor at Coin World, a trade publication headquartered in Sidney, Ohio.

Some continue to hold out hope that the market for gold bullion will rally too. The Persian Gulf crisis is not resolved, so war could still break out, sending the price of gold soaring, Nadler said. Even if war is avoided, U.S. gold prices should still rise on the basis of “fundamentals”--such as high interest rates, high inflation, a weak dollar and a generally souring U.S. economy.

“We are probably going to continue to see gold prices coming back as inflation rises,” said Zaner. “But you can’t act hastily. Investors have to look at gold as a long-term investment.”

Yet many analysts believe that the gold market is bound to languish for some time, despite the weaker economy and volatile world situation.

Gold is the asset of last resort, meaning that people tend to flock to it only when they see little hope for stocks, bonds and currency, said Joseph Wahed, senior vice president and chief economist at Wells Fargo Bank in San Francisco. And these days, people are simply more confident about the world economy, about the value of their own currencies and about their respective banking systems, he said.

Moreover, today’s economy, although weakening, is in much better shape than in 1980, when gold prices peaked. A decade ago, inflation was running at 12.5% annually and 7% of the nation’s workers were unemployed. Meanwhile, the prime rate was hovering around 15.3%, according to the Federal Reserve, which made it difficult for businesses to borrow and expand.

In contrast, inflation is now running at a 4.7% annual clip, the unemployment rate is at 5.5% and the prime rate is at 10%.