Gold glitters again as investors await Fed

Over the course of the last few weeks, gold has begun to shine more brightly than it has in many months. But will this rally last?

By The Fiscal Times Sep 10, 2012 4:24PM
By Suzanne McGeeThe Fiscal Times logo

Over the course of the last few weeks gold has begun to shine more brightly than it has in many months. The price of the precious metal has once again soared above $1,700 an ounce, driven by increasingly intense hints from the Federal Reserve that a third quantitative easing program is not only possible but imminent. Whenever the prospect of cheap money looms large on the horizon, this is how gold tends to behave, so being a gold bull is probably one of the safest bets in today's uneasy and uncertain financial markets.

But will this rally last? Or will those who are just now looking to get in on the gold rush find themselves on the wrong side of that old Wall Street axiom, "buy on the rumor sell on the news?"

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If or when the Fed announces its QE3 plans in greater detail, gold could climb higher still. Some analysts have set their year-end price targets at or around $2,000 an ounce. But at some point, investors could understandably get skittish again about the high price commanded by the metal. Remember that gold, despite its long bull run in recent years, has an uneven track record as a store of value. And in contrast to many other commodities, it has little in the way of fundamental supply and demand to support those prices.

Sure, there's demand for gold jewelry as a woman’s dowry in India and the Middle East; folks like Syria’s dictator Bashar al-Assad are probably pondering switching any paper assets they can still get their hands on into more portable forms of wealth, like gold. But other than that, gold’s utility value lies in the eyes of investors. About 90% of the demand for gold comes from jewelry manufacturers and investors snapping up Krugerrands or other gold coins -- in other words, it is driven by psychology and other emotions.

The biggest source of fundamental "demand" for gold is the market’s degree of fear and uncertainty. Right now, there’s a lot of that around, given the dismaying signs of economic weakness in crucial parts of the globe, from Europe and the United States and even from China. We tend to buy gold when we are fearful, in the expectation that other people who are fearful will want to spend a still higher price to acquire it.

So why might a round of QE3 be great for gold, at least in the short term? Looser monetary policy -- all that stimulus -- weighs on the value of the dollars that are out there already, making gold (which is priced in dollars) look cheaper than other dollar-based assets to investors looking for a place to park their yen, Swiss francs, and so on. There also is a theory that gold is a great inflation hedge, and that quantitative easing raises the risk of future inflation. (That theory hasn’t worked out so well; we’re still trying to create growth here, not worrying much about inflation outside the world of oil and food prices.)

Some gold bugs love the very idea of the metal, and argue that one way to return global finances to order is to have them tie their currencies to it. The odds of that happening are slim to non-existent, despite what you may have read about the Republican platform a couple of weeks ago.

Returning to a gold standard would put a disproportionate amount of power in the hands of nations with extensive gold reserves, something that many countries will be reluctant to do voluntarily. So, if you’re thinking of hanging on to your gold because you are convinced that one of these days governments worldwide will come to their collective senses and abandon their currencies for the only kind of money that "counts" -- well, you might want to rethink that from a more pragmatic point of view. It certainly isn’t a reason to be buying gold at or close to its current highs.

At some point, gold’s price is going to come back down to earth for a few very fundamental reasons. First of all, gold doesn’t generate any kind of yield or return. Indeed, it generates a net cost to investors, whether for storing the metal itself, for turning over futures contracts or for paying ETF or mutual fund management fees. Secondly, it’s almost impossible to calculate how much the precious metal is "really" worth at any point in time because, again, it all boils down to psychology. Thirdly, in psychology-driven markets, at some point investors get nervous and twitchy, and begin to edge toward the exits. Unless you’re very confident that you’ll be able to judge when to make that sprint yourself, think twice.

Sadly, no one has yet devised a way to invest in the guys -- you’ve seen them on late-night television or heard them in radio spots -- who make a living playing on fear and anxiety by urging investors to trade in their portfolios for gold coins. Failing that, one way to profit from others’ anxiety about gold is to hunt for mining stocks and snap up shares of those with significant reserves that are able to extract gold at a reasonable cost basis and still trade at reasonable valuations -- Barrick Gold (ABX) springs to mind, for those who like ultra-liquid large cap stocks. Or look instead at big metals companies like Rio Tinto (RIO), whose production includes gold as well as base metals. If QE3 pays off and helps restart the U.S. economy, then demand for those other commodities is likely to benefit as well.

The higher gold climbs in the near future -- and yes, it’s not impossible that sentiment alone could propel it to close to $2,000 an ounce -- the greater the risk that it will tumble once sentiment begins to shift. That just increases the risk of owning it.

Suzanne McGee is a columnist at The Fiscal Times. Subscribe to The Fiscal Times' FREE newsletter.

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