Gold has traditionally served as a safe haven for investors in times of economic turmoil or as a store of value during inflationary periods. The Economist recently argued that now is the time to invest in gold. The basic argument is that gold will perform well regardless of how well monetary policy achieves its goal of turning the economy around.
If slashing interest rates has the desired effect, the U.S. economy will likely enter into an inflationary period. This should spur a rally in gold as investors seek a hedge against the effects of inflation. If low interest rates fail to turn the economy around, gold should continue to benefit from the fear-driven buying that has driven it to its current level of around $950 an ounce.
The effect of economic deterioration on gold is evident in the way that it has traded since the first of the year. The average monthly trading volume for SPDR Gold Trust (GLD) is up over 200% since the beginning of the year. Its safe to say that if gloomy economic news continues to emerge gold prices will at least hold up.
However, the argument that increased inflation will be similarly bullish for gold is off the mark. A good deal of the upward pressure on gold prices has been speculative trading. If low interest rates are successful they will bring back more than inflation.
Barring a Carter-era anomaly, inflation will be a function of a recovering economy. When the economy reaches this point speculators will be looking for opportunities in assets that did not experience a run-up while the recession was still in progress. Economic recovery may pose the greatest risk to gold investors.
Garrett McIntyre
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