August 19, 2011

That's a question we get asked a lot lately. Stocks have been weak, bond yields low, and gold has been surging, closing yesterday at roughly $1800 per ounce. The price per ounce has more than doubled since mid-2009, drawing plenty of attention from investors and analysts. This raises two questions:

  1. What are the factors underlying the sharp rise in price?
  2. Does the rise point to more increases, or is the current price unreasonably high?
The factors driving the current steep jump in gold prices seem mostly related to fear and uncertainty. Gold has been seen as a haven in uncertain times, and has been considered a reliable store of value over centuries and across cultures. But unlike bonds, real estate, and some stocks, gold does not pay any income. And gold in coin or bullion form must be stored. The fear aspect of demand puzzles me. Unless you're expecting an end-of-the-world "Mad Max" or "Night of the Living Dead" scenario, do you really think you'll be buying eggs and milk at the grocery store and paying in gold? Not likely. The more likely reason for the spike in gold prices is a collective lack of confidence: in national governments, in big banks, in Wall Street. Politicians, bankers, and traders seem to take good care of themselves, and when one needs help the other is there with bailouts or campaign contributions. Workers facing layoffs don't have that luxury, and cynicism on the part of investors may make them look at alternatives. After all, a bar of gold won't lay off 10,000 people and then pay itself a bonus.

But will gold keep going up? Though at an all-time dollar high, gold is still below its 1980 peak when adjusted for inflation. Factors that point to more gains include growing prosperity in India and China, both traditional net buyers of gold, and volatility in securities markets that can scare investors into buying gold. But if you are old enough to remember the last time metals prices spiked - 1980 - you will recall that it seemed like everyone was buying and selling gold. That spike didn't end well, with prices per ounce down 50% two years after the 1980 peak. When everyone seems to want to buy the same asset, eventually everyone does. After that, who's left to buy? It happens in every bubble, and that's your risk now.

GTC

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).