Friday, February 12, 2010
Analysis
The Timeless Allure of Gold

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By Dunstan Prial
FOXBusiness

The argument for buying gold during tough economic times is nearly as old as the precious metal itself.

Indeed, when other currencies and commodities are losing their value, the siren call of gold is practically irresistible.

Entire countries have jumped on the gold band wagon of late, with India purchasing 200 tons in November, the single largest purchase of the commodity by a government central bank in three decades. Recent rumors that China is strongly mulling a big purchase similar to India’s have kept the price of gold above the $1,000 an ounce range, according to analysts.

After hitting a record high last month of just over $1,225 an ounce, the price has tapered off a bit, but not by much. It was trading at $1,090 an ounce on Friday.

Gold mining companies such as Gold Fields Limited (GFI: 11.9, 0, 0%) and Newmont Mining Corporation (NEM: 46.54, -0.26, -0.56%) have also benefited from the recent surge.

First, though, a little perspective is in order. The current price of gold is still well below its value three decades ago when inflation is taken into account. In 1980, gold hit a then-record $873 an ounce. In today’s dollars, that would be $2,287, according to the U.S. Labor Department’s inflation calculator.

Still, the shift in investors’ attention toward gold during the recent economic crisis has been dramatic.

Here’s commodities expert Kevin Kerr explaining gold’s allure: “Gold is attractive for investors for the simple reason that it is a comfort commodity. Much like a bowl of warm soup on a cold winter day it makes us feel warm and secure inside. Let’s face it, as the fiat currencies around the world get beat up each week, gold is one of the few places investors can put their money and not watch it whither.”

No argument here. But after a months-long runup since October 2008, when gold cost about $700 an ounce, the question is whether gold is a bubble that’s about to burst.

“No way,” says Kerr. “We’re just getting started.”

His entirely plausible reasoning is that investors will continue to turn to gold as the Federal Reserve – and other global central banks – struggle to pull back from the liquidity and stimulus programs that prevented the world’s economy from falling off a cliff.

“The bottom line is that gold will simply become more and more attractive as it becomes clearer and clearer just how bad a pickle the Fed is in. They simply cannot raise (interest) rates,” Kerr said.

The combination of easy credit fueled by low interest rates and rivers of stimulus money flowing from the coffers of various central banks is bound to lead to “hyper inflation,” and Kerr believes gold is the obvious hedge against that dynamic.

But there’s no reason to panic or go gold crazy.

Kerr recommends dedicating no more than 10% of an investor’s portfolio to precious metals. Given the precarious state of the world’s economy, he recommends leaning toward the higher end of that range at the moment.

Like any good investment argument, however, there other points of view.

Billionaire investment guru George Soros, in an interview last month from the World Economic Forum in Davos, Switzerland, described gold as “the ultimate asset bubble.”

Soros was ambiguous as to whether he felt gold was a bubble about to burst or one still rife for expansion Nevertheless, his point was pretty clear – investment trends come and go (Think dotcom companies and real estate in just the past decade.) but gold remains constant.

Seemingly unspoken in Soros’ statement at Davos was that what goes up must come down. Investors need only to look at the price of oil 18 months ago as it soared above record highs to nearly $150 a barrel.

The argument at the time was whether speculators had helped push the price up or whether supply and demand alone had created the surge. (A lot of both factors contributed, actually.) Eventually, as demand weakened and supplies of oil built up the price plunged to below $40 a barrel.

There is little doubt that gold will eventually hit a ceiling once the economy shows more sustained strength and interest rates start climbing higher.

As with many investment dilemmas it really comes down to timing: when and at what price will the gold rally end? No one knows, of course.

With central banks holding interest rates near zero, and Europe on the brink of bailing out Greece, gold remains a good investment as a hedge against inflation. And with additional risks lurking on the horizon in the form of Spain, Portugal and Ireland, risk-aversion will remain at the forefront of investor thinking.

So don’t expect an end any time soon to the current gold rush.