Tags: gold | QE | bears | Fed

Gold Is Down But Not Out

Friday, 27 December 2013 07:04 AM Current | Bio | Archive

Gold prices are down about a third from their all-time high in 2011 and the U.S. economy seems to have picked up enough steam for the Federal Reserve to start tapering its quantitative easing (QE) programs. Is it time to throw in the towel on gold?

While the bears have painted a pretty mediocre-to-bad-case scenario for gold in 2014, there are a couple of possibilities that gold will still have relevance as an investment.

First, the stock market bubble may burst. Without the crutch of QE to support record highs in the stock market, stocks will have to stand on their own. The fact that revenues have generally been stagnant, profit growth has come mostly from cost cutting and financial engineering and price-earnings ratios have climbed, stocks could be headed for a rough time unless the economy robustly improves. A loud popping sound may revitalize interest in gold.

Second, the U.S. economy is not that good. It is certainly in much better shape than in the worst days of the financial crisis, but it is a shadow of its former self. The employment numbers look better because a record number of Americans have dropped out of the work force, and many of the new jobs created have been part time and low paying. And the manufacturing sector jumped last month because of building inventory, not from increased orders. This modest and fragile recovery is likely to be the new normal. Low gold prices make the upside potential more appealing than overpriced stocks.

Third, fiscal policy remains in shambles and monetary policy has run its course. The new two-year budget deal prevents the series of last-minute crisis that led to the partial government shutdown, but does very little to stop the piling up of huge amounts of debt. Current tax revenues do not even pay for entitlement spending.

The Fed is tapering QE because of some encouraging signs in the economy, but it was also facing the problem of printing so much money and getting so little out of it. The crushing debt may jeopardize the full faith and credit of the U.S. government, which would hurt the dollar and help gold.

Fourth, there are significant risks with tapering the Fed's QE programs. There has never been an attempt to unwind a $4 trillion program. Ending QE during a weaker economy or a robust economy may cause aggressive inflation.

Reducing the purchasing of mortgage-back securities may have a dramatic impact on the housing market. The right path is narrow indeed and government tends to be a blunt instrument with unintended consequences. Inflation usually lowers the value of the dollar and raises the price of gold.

Fifth, demand for physical gold worldwide remains near historic records. A growing middle class in Asia, especially in India and China, has created a buying frenzy for physical gold.

India was importing so much gold that it threatened to tank the rupee, so the government significantly curtailed gold imports.

China's Lunar New Year is coming up and it is the biggest gold-buying season in China. Further, Asian investors tend to hold on to gold and pass it down to family, which further limits supply.

And gold's low prices are near the break-even point for most gold miners, causing the closures of mines. If U.S. demand increases for gold, the short supply may accelerate the rise in gold prices.

Finally, if the gold bears are right, gold may have lost its safe-haven status and is a speculative investment instead of a hedge. But it has not lost its status as a tangible asset that should be a part of many investors' diversified portfolios. Gold may fluctuate in price, but it will never be worth zero like a stock or a bond could be.

At these low prices, going long on gold may be a good strategy. Buying some and putting it away in a safe place, like a home safe or safety deposit box or a depository, or rolling part of an IRA into a gold IRA may be a prudent move.

And all this does not take into account the possibility of an unexpected shock to the U.S. or global economy. A cyber attack on our banking system or another terrorist attack on U.S. soil could break our fragile recovery. A major military intervention in an unstable part of the world, such as a pre-emptive attack on a pre-nuclear Iran, would jeopardize the West's flow of oil, forcing the global economy off track.

Gold may have lost its speculative allure in 2013, but there are many reasons why gold can be relevant in 2014. When all is said and done, gold has endured longer than credit default swaps and derivatives have and will continue having a role in a prudent investor's portfolio.

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Gold prices are down about a third from their all-time high in 2011 and the U.S. economy seems to have picked up enough steam for the Federal Reserve to start tapering its quantitative easing (QE) programs. Is it time to throw in the towel on gold?
Friday, 27 December 2013 07:04 AM
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