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Price plunge only a temporary tarnish for gold, which still glitters with promise

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Saturday, April 20, 2013, 9:00 p.m.
 

There are three primary reasons to invest in gold.

In addition to acting as a hedge against inflation, gold is an insurance against monetary catastrophe and a medium for speculation.

Today, inflation appears tame, with growing evidence of recession. As investors move toward cash, commodities — including gold — decline in price, especially when valued in strong dollars. Troubled Eurozone countries might be forced to sell gold as a prerequisite to receiving further bailouts.

Selling by speculators and inflation hedgers has pummeled gold prices, sending them down about 35 percent from their high. Last week, The Financial Times reported one hedge fund manager, John Paulson, losing $1.5 billion in gold. Has gold lost its luster?

After the Sept. 11, 2001, attacks, the Federal Reserve opened all monetary spigots threatening inflation. Hedgers swarmed in, pushing gold from less than $300 to more than $1,000 an ounce, far out-performing equities. That attracted momentum playing hedge funds and speculators, which drove gold to its record high of $1,920 an ounce on October 19, 2008.

Weeks later, in late 2008, the recession pulled commodity prices down. Inflation hedgers sold gold in trades from $1,600 and $1,800 per ounce. This narrow price range did not allow recent gold investors returns competitive with equities or bonds feeding on the morphine of Quantitative Easing. By early 2013, gold had fallen to about $1,500.

In March, the prospect of future bailouts for Cyprus hinted at forced sales of Cypriot Treasury gold. Cyprus has just 14 tons of gold. If Cyprus is forced to sell, it could herald far larger distress sales by other debt-troubled Eurozone nations, including Portugal (382 tons), Italy (2,452), Greece (112), Spain (282) and even France (2,435 tons). That's 5,677 tons, or about 18 percent of all gold held by central banks. The potential overhang apparently encouraged further sales by speculators, causing gold to threaten key support levels as low as $1,300, $1,150 and $975 an ounce.

Recent downgrades of global economic growth rates forecast by the International Monetary Fund, increased statistical evidence of looming recession and the recent gold sell-off have squeezed out many inflation hedgers and speculators.

However, some inflation hedgers are well cushioned, having invested at below $1,000. Furthermore, as evidence emerges of growing official skepticism about the effectiveness of QE and speculation as to its possible reduction, some investors sense increased risks of monetary trouble — even catastrophe. Their concerns appear to be shared by central banks, which continue to accumulate gold.

In particular, the central banks of newly rich nations have very low ratios of gold to paper in their reserves. For example, China has 1,054 tons or about 2 percent of its total reserves. China's thirst for gold is shared by other surplus nations.

Investors fearing monetary catastrophe might do well to imitate central banks, who are the ultimate insiders. However, some might wish to hedge, at least while recession threatens.

John Browne, a former member of Britain's Parliament, is a fianancial and economics columnist for Trib Total Media. Email him at johnbrowne70@yahoo.com.

 

 
 


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