A 24-carat safety net for investors

The weak dollar, the volatile stock market, the lackluster economy, the yawning budget deficit, the accommodative Federal Reserve — all this and more have people rushing for gold.

The metal touched a high of $1,424 an ounce on Tuesday, although the price remains well below the peak of the early 1980s once inflation is taken into account.

“It’s in effect a protest vote that there’s something amiss with current policies,” said First Eagle Funds portfolio manager Abhay Deshpande, who is also a longtime gold investor.

“People are almost acting as their own central banks because the advantage of gold is that it acts as a hiding place in times of currency turmoil,” Deshpande said. A steady drumbeat of higher price targets from Wall Street firms — as well as recent pronouncements from political leaders — has buttressed what was already strong investor demand. Just as the Tea Party has moved from the political fringes to prominence in Washington, so gold has become a touchstone for policy makers and investors alike. On Monday, the president of the World Bank, Robert B Zoellick, surprised experts when he suggested the price of gold should be considered a financial yardstick, reversing 40 years of relying on paper currencies to store value in the international monetary system.

Deemed intrinsically valuable for thousands of years, gold has traditionally been a hedge against rising inflation and political or economic uncertainty. But this time around, investors worry that the Fed’s move last week to pump $600 billion into the nation’s banking system, as well as a surge in borrowing around the world, will undermine paper currencies, making gold a refuge once again. Over the last two months, the dollar has declined 6 per cent against its principal peers, but gold has jumped 17 per cent.

At an investor conference in Berlin, whether the worry was inflation, deflation, sovereign debt risk or currency instability, “market participants looked to gold as a potential answer,” said Barclays Capital precious metals analyst Suki Cooper. But it is Washington that has prompted the latest surge.

“As the Fed prints money, markets are anticipating that more dollars will be chasing the same supply of commodities, driving prices higher,” said New York-based Perella Weinberg Partners’ Xerion fund manager Daniel Arbess.  And while gold is the most obvious example of this trend, other commodities are rising, too. Wheat, copper and cotton all soared on Tuesday.

Nor is gold fever restricted to hedge fund managers wielding billions of dollars. Individual investors have also been clamoring to get in on the trade, scooping up gold coins like one-ounce American Eagles and South African Krugerrands.

“People are coming in to buy 50 or 100 coins at a time, which is pretty hefty for individuals,” said Mark Oliari, chief executive of CNT Inc, a Massachusetts coin broker. “It’s not just rich people, either. A lot of people are putting 30 to 35 percent of their net worth in gold; they are scared to put money in paper assets.” Signs of gold’s renewed appeal have been building for months, as well-known Wall Street figures like George Soros and John Paulson piled into the metal. JPMorgan Chase even reopened a long-closed vault below the streets of downtown Manhattan to meet investor demand to store the stuff.

And the recent comments by Zoellick  only confirm gold’s new status. “The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values,” Zoellick said.  “Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.” But in a sign of how volatile gold remains, it closed sharply lower at $1,392.90 on Tuesday, down from the intraday high of $1,424, after comments by the governor of the Bank of Canada, Mark J Carney, that gold “has no role to play in the international monetary system,” according to Reuters.

As gold has become more respectable, it has also become easier to invest in. Some people may still regard bars of gold in a vault as the ultimate insurance policy, but exchange-traded funds, or ETF’s, that hold gold have also exploded in popularity.
Besides driving down the dollar’s value by sharply increasing the amount of dollars in the system, the Fed’s action also helps gold by lowering interest rates. That is because a traditional knock on gold is that it doesn’t yield interest payments or dividends, but with short-term rates closing in on zero, there is much less to lose by holding gold.

In addition to the opposition from investors, the Fed’s decision to pump $600 billion into the banking system, a policy known as quantitative easing, has met with sharp criticism from several of America’s crucial trading partners, including Germany, China and Brazil.
They say flooding the world with unwanted capital at a time when their own economies are already growing at a brisk clip increases the odds of inflation down the road while encouraging one country after another to devalue its currency.

As the dollar has fallen, countries like Thailand, Japan, Brazil and others have taken steps to weaken their own currencies, in what some see as the beginning of a race to the bottom. Since the depths of the financial crisis two years ago, gold has risen 91 per cent, and it is nearly a third higher than just one year ago.

While gold has touched new records in nominal terms, when adjusted for inflation the price remains 40 per cent below its real record high, which was reached in 1980. What is surprising economists is not the rise of gold prices, but the speed of its ascent.