Gold's future shines as dollar's luster fades
Investors seeking a safe haven during these volatile political and economic times are favoring gold over dollars. However, those looking to invest in gold can expect a roller-coaster ride, at least in the short to medium term.
There are five main reasons why gold is attractive:
• Inflation is still “officially” low. However, unprecedented money creation by the Federal Reserve and the European Central Bank is encouraging an increasingly strong conviction that inflation will be a threat. As a store of value, gold is purchased as a hedge against inflation.
• European Central Bank President Mario Draghi's assurances that he can save the Eurozone have encouraged a euro recovery from $1.22 to $1.30 against the dollar. A falling American dollar leads to higher prices for all commodities — including gold.
• America has lost some of its influence in the Middle East amidst anti-American film protests and other developments. The risk of war there is rising, as is the possibility of armed conflict over disputed territorial claims in the East China Seas among China, Japan, Taiwan, Vietnam and the Philippines. All of those concerns encourage gold buying.
• Central banks that were once huge sellers of gold, such as those in India and Russia, now are accumulating gold along with China. Savvy investors pay close attention to the actions of central banks, the center of global money power and influence.
• Throughout history, gold has been used universally as a medium of exchange, or currency. As the United States leads most other countries in a currency debasement race to protect exports, investors are becoming increasingly distrustful of paper currencies. Gold, therefore, is gathering added investor trust and support as a currency alternative to paper.
Aside from these bullish factors, there are important considerations to consider before investing that normally would indicate a downward pressure on the price of gold.
The rate of growth in gross domestic product is are falling alarmingly in the European Union, which has the world's largest economy, followed by the sluggish United States in second place. China's once-roaring economy is slowing. Japan, in fourth position, has experienced a slump lasting almost 20 years. There are growing fears of a worldwide recession.
In a recession, cash becomes increasingly scarce and real assets, including commodities, fall in price. As a commodity, gold should fall in price as recession becomes manifest.
This may tempt some investors to sell their gold, while those fearing inflation will buy.
Some investors, however, may have overlooked an important consideration. Despite falsely low interest rates, most of the trillions of dollars created by central banks are sitting in bank deposits or in the bond portfolios of banks. As such, they form part of the monetary base and are not strongly inflationary. It is not until the banks start lending money from these vast deposits that monetary base translates into money supply and becomes highly inflationary.
Those who have bought gold as a near-term inflation hedge may become significant sellers as recession deepens.
Yet the euro's basic viability still is at risk. The standing of the dollar is questioned. As threats of a sudden currency collapse increase, investors can be expected to turn to gold, driving its price upwards.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Email him at firstname.lastname@example.org.
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