New 3G Flash in the Pan—Gold, the G-20 and the GOP

New 3G Flash in the Pan—Gold, the G-20 and the GOP

As world leaders headed to South Korea for their G-20 summit amid mounting European debt woes and rising risks of currency and trade wars, gold continued its meteoric rise. On Tuesday, the precious metal hit an intraday high, in nominal terms, of $1,424 an ounce before closing at $1,392.90 after the dollar rallied. It was the fourth record high for gold in a row, and the latest sign of high anxiety over paper currencies, particularly the dollar.

The greenback rose 0.9 percent against an index of other currencies Tuesday as new debt troubles emerged in Greece and Ireland, and investors sought shelter in the dollar. Still, most experts believe the longer-term trend for the dollar is downward. The drivers: America’s own massive deficits, and the Fed’s apparent determination to hold interest rates down by buying boatloads of Treasurys. While the Fed’s strategy may boost growth in the short term, many fear it could reignite inflation longer term – and undermine paper currencies.

Just how deep that fear is running was spotlighted earlier this week when World Bank President Robert B. Zoellick – hardly your typical gold bug – stunned the financial community by suggesting that gold should replace paper currencies as a financial yardstick for monetary and exchange rate policies. Such a move would reverse nearly 40 years of policy reliance on paper currency, since President Nixon took the U.S. off the gold standard in 1971. “Although textbooks may view gold as old money, markets are using gold as an alternative monetary asset today,” Zoellick wrote in The Financial Times.

And investors big and small have been scooping it up. “We’re in vogue for three years then out for 25,” said Dana Samuelson, president of American Gold Exchange, as attendees at the New Orleans Investment Conference checked out his American Eagles, Canadian Maple Leafs and South African Krugerrands. “The last time business was this good was in the 1980s when we were fighting double-digit inflation.” 

Also increasing their purchases of late have been central banks and Wall Street mega-investors, including George Soros and John Paulson. To meet mounting client demand to store their gold bullion and coins, JP Morgan Chase recently reopened a long-closed vault beneath the streets of downtown Manhattan.

Bubble Talk
As gold continues to climb, there’s debate about whether we’re in a bubble that’s about to pop or whether this is just the beginning of a longer-term surge.

Only two weeks ago, at the New Orleans conference, the word among gold buyers was that the precious metal had risen so far so fast that a correction was virtually inevitable. “Gold has risen 95 percent in the last 10 months, and we’ve not had more than a 14 percent correction in the last two years, making this the longest rise without a correction,” said investment analyst Pamela Aden of Costa Rica-based Aden Research.

But after the GOP sweep of the House and the Fed’s announcement of a second round of Treasury purchases, gold took off again. Of course, a correction is still possible, maybe even likely. And yesterday’s pullback at the close – and today’s drop in gold futures – could be a warning signal. If euro zone debt concerns lead to a sustained dollar rally, that could trigger the correction as investors seek a safe haven. That’s what happened during the euro zone debt crisis earlier this year. Gold fell 13.13 percent in February and 7.95 percent in July before resuming its ride up. But that doesn’t mean the bull market in gold is over. “A 20 percent correction would be healthy,” says Aden. “Then I’d be buying.”

Longer term, the stars seem well-aligned for a continued rise in gold. If you adjust for inflation, gold is still 40 percent below its inflation-adjusted high of $2,387 on January 21, 1980. And many experts believe it has a long way to go. “It’s clear we’re in mega-bull market, which tends to last for decades,” says Aden. “Bull markets tend to happen once or twice in a lifetime but go for many years. Eventually they end in a bubble, but we’re nowhere near that point in the cycle. We think we’re just getting started.” Aden thinks gold could easily hit the $2,300 zone before this bull market is over. 

What’s Driving Gold Upward
Among the key drivers of the demand for gold is mounting concern that the U.S. will debase its currency by dealing with its mounting debt, not primarily by raising taxes or cutting spending, but through inflation. That way the government needs fewer dollars to pay back its lenders. Warns Brien Lundin, editor of Gold Newsletter and president of Jefferson Financial, which sponsors the conference: “The only way out is inflation. It’s a time-tested strategy. But it destroys the value of everything – unless you own gold.”

Others say inflation fears are overblown, at least in the short term, given the weakness of the U.S. and European economies.  The surge in demand for gold is “not about inflation,” says Nariman Behravesh of HIS Global Insight. “It’s a hedge against a weak dollar, not a hedge against inflation.” 

Both concerns may help explain why foreign central banks, which have long held dollars as a reserve currency, are increasing their purchases of gold. “If you are the monetary authority of Malaysia or Indonesia or India or China, at margin your propensity to be a buyer of gold and seller of dollars, euros, sterling is quite high and rising,” says Dennis Gartman, editor of The Gartman Letter, a respected investment newsletter that covers precious metals.

There is also mounting demand for gold from emerging market consumers, particularly in China and India, where gold jewelry is prized. Add to that a limited supply with few new discoveries, and you have a formula for continued price appreciation.

What Investors Should Do
Investors should think about gold in two ways.

First, consider gold as a store of value and a hedge against inflation. If you think the Fed’s policies will lead to a resurgence of inflation down the road, you might want to buy some gold or gold ETFs as an insurance policy.

Second, gold can be seen as a speculative investment. If you think the dollar is in a long-term downdraft and emerging markets will continue to grow at a robust pace, gold – and other commodities like silver and copper, which have also been on a tear – should continue to rise. But remember, these commodities have risen sharply already and are historically very volatile. So, if you’re not in yet, you may want to move in slowly, or wait for a pull back. And one more thing: Be sure to buckle your seat belt.