12/03/2009 12:36 pm ET | Updated May 25, 2011

The Case for Gold is Airtight. Which is Bad for Gold.

There's no shortage of doubt about most investments these days. (Are emerging markets in a bubble? Are Treasuries a trap for the wary?) But there is no doubt about gold. The yellow metal keeps hitting records, this morning at over $1,200 an ounce. What's more, it's hard to find a reason for it NOT to go higher.

That's why it's strange that Jim Grant, one of gold's most eloquent long-term fans, is turning lukewarm on the hot metal. This is the sort of market that should make him feel utterly vindicated. But Grant is less a true-believing gold bug than confirmed contrarian. And when any asset seems pre-ordained to go higher, Grant gets nervous.

Here's what everyone can see:
  • Gold generally outperforms when there is a lot of doubt about the economy and financial assets. We got that.
  • Gold tends to shine when central banks are printing a lot of paper money. They are.
  • Gold naturally does well in dollar terms when the dollar is falling against other currencies. Check that, too.
Grant raises another scenario that's even more bullish for gold. Most central banks keep a certain portion of their foreign reserves in gold. The share of reserves in gold is much higher in developed economies than in emerging ones. In the U.S, for example, gold accounts for 77% of total official foreign exchange reserves. In China, it's just 1.6%. But what if the emerging countries wanted to close that gap? (India, in fact, bought 200 metric tons of gold in early November, claiming it was diversifying its reserves.) Grant quotes his colleague Ian McCulley:

For a thought experiment, consider the nine foreign exchange reserve holders in the world that are currently 'underweight' gold ...The list would include Brazil, Russian, India and China, along with a handful of wealthier Asian countries. If the nine got it into their heads to boost their gold holdings to 10% of their reserves, they would have to acquire 11,174 metric tons; to 25%, they would need 33,254 metric tons.

McCulley points out that there only 150,000 tons of gold above ground in the entire world. Grant concludes dryly, "You could talk yourself into some fancy bullion prices."

So why is he lukewarm? Grant doesn't advance any arguments not to believe in gold for the long run, except to point out one thing: This is how markets look at the top. Investors always miss turning points. He quotes the impressive logic of gold bears just 10 years ago who patiently explained that gold was a relic-this was when it was trading at $250 an ounce. This was the same era in which the British Treasury worked out a seemingly ironclad argument for why it made sense to sell gold at $275. (CBS MoneyWatch columnist Larry Swedroe makes a similar point in this post.)

Unlike stocks and bonds, gold produces no income, so it's hard to ascribe any intrinsic value to it, as, say, Warren Buffett would to a security. It is more of a barometer of anxiety about the financial system, which is high. And, like any other asset, it can trade on its own momentum. In other words, as my colleague and former gold trader Jill Schlesinger puts it in this post, gold may have reached the point where it's going up because it's going up.

The timing of all this is anyone's guess, of course. But what you do know for sure is that fear eventually gives way to optimism and momentum always reverses. You can count on it. Grant's conclusion, paraphrasing Churchill:

...this may not be the beginning of the end of the gold bull market. But it is certainly the end of the beginning.

Put less elegantly: You can believe in the long-term case for gold, as Grant does. But you don't have to buy the stuff at $1,200 an ounce.

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