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The Case For Gold

Last updated 11/23/2009 2:04 AM ET (GMT -5) 0 Comments - Add your comment

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Boris Schlossberg

Director of Currency Research, GFT

As gold continues to set daily record highs it is encountering a rising chorus of criticism from skeptics who view at as the latest asset bubble to burst soon.  However, while the precious metal may be vulnerable to a near term pull back  in order to consolidate its latest gains, we believe the long term case for gold remains bullish.

Contrary to popular perception gold is not a hedge against inflation. Most investors make that association because the last time the yellow metal experienced a secular bull market in the late 1970’s and early 1980’s US price levels rose at double digit annual rates. However, gold& #8217;s actual correlation with inflation  is relatively weak. Indeed,  in today’s  economic environment  prices levels in G-10 are at multi decade lows and deflation rather than inflation is a far greater concern and yet gold rises relentlessly.

Why then the sudden strength in gold? As its many critics point out, aside from wedding demand from India, gold is now a near useless commodity replaced in industry by better more efficient substitutes.   Gold however remains a strong psychological store of value and more specifically it is the primary asset for expression of  no-confidence by investors in the fiscal policies of the state.

As investors look ahead to 2010, the debate between the recovery bulls and the double dip bears remains at a standstill, but markets are in near universal agreement  that fiscal deficits in US, UK and to a smaller extent in the Euro-zone will continue to mount as the gap between expenditures and tax revenues widens alarmingly even as GDP growth rebounds.

With the exception of Australia and Norway, governments in all other advanced industrialized nations are under enormous pressure to keep their spending policies in place in order to assure the sustainability of the recovery in 2010. Furthermore,  in a an atmosphere of extraordinarily high unemployment rates across much of the industrialized world, politicians will find it exceedingly  difficult to raise taxes next year, as  they face the full wrath of voters who are already pinched by stagnant wages and high debt burdens.

Investors are clearly sensing that this dynamic shows no signs of improvement and it is this realization that has been the primary catalyst behind the rally the gold.  Some skeptics have pointed out that while gold may continues to perform well  during times  of financial stress  it  will be near worthless as an asset in case of true political turbulence (world wars, economic doomsday, etc.) as investors lose faith its real world purpose.  We completely agree. However before  any real doomsday scenario takes hold it is likely to be preceded by a protracted period of financial turbulence which will only enhance the yellow metal’s appeal in the near term.  

There is no doubt that any rally in gold will ultimately end in tears as the asset goes parabolic and  then crashes, but any concerns about such a move a premature.  For the time being the rally in gold is climbing a wall of worry while the growing fiscal problems in G-10 universe continue to raise doubts about fiat currencies. If 2010 does not see a marked improvement in economic activity that quickly replenishes the tax coffers of G10 nations, the financial stress of the situation will likely result in fresh record highs for gold.

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About The Author

Boris Schlossberg began his Wall Street trading career more than 20 years ago at Drexel Burhnam Lambert. There, he traded nearly every type of financial product on the market in the U.S., from equities and options to stock index futures and foreign exchange. His innate ability to analyze market information and use it to trade has helped him become an industry-recognized, “go to” trading professional.

These days, whenever the markets move, many organizations turn to Schlossberg for his take on the situation. He is a weekly contributor to CNBC's Squawk Box and a regular commentator for Bloomberg radio and television. His daily currency research is widely quoted by Reuters, Dow Jones and Agence France Presse newswires and appears in numerous newspapers worldwide. Schlossberg has written for publications like SFO magazine, Active Trader and Technical Analysis of Stocks and Commodities. He is also the author of Technical Analysis of the Currency Market and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Kathy Lien. He joined GFT in 2008.