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Gold verses dollar { June 19 2003 } Original Source Link: (May no longer be active)
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2003/06/19/BU190365.DTLhttp://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2003/06/19/BU190365.DTL
Is gold a hedge or a trap?
Kathleen Pender
Thursday, June 19, 2003
©2003 San Francisco Chronicle | Feedback
Gold traditionally has been touted as a hedge against inflation. So why, at a time when the Federal Reserve is worried about deflation, do so many smart money managers like gold?
Pick a reason, any reason:
-- It's a hedge against geopolitical turmoil.
-- It's a hedge against deflation.
-- It's a hedge against inflation, which will rear its ugly head once efforts to stimulate the economy take hold.
-- It's a hedge against a falling dollar.
-- A new exchange-traded-fund, which will sell shares in a pile of gold bullion, will create new demand for gold, assuming it gets approved.
-- All or some of the above.
Today, we'll take a closer look at these arguments. On Friday, we'll look at various ways to buy gold.
But first, this warning: Gold is an unpredictable, highly volatile investment that's subject to worldwide economic, currency and political risks.
"Gold can break your heart," says Lynn Russell, who follows gold mutual funds for Morningstar. "Think of all the people who bought gold in 1980 (when it traded above $800 per ounce) and 20 years later have never come close to recovering even half of their investment."
If you buy gold at all, it should be used, sparingly, as a wild card in your investment deck.
"It has a minus correlation to most other investments. It tends to do well when other things do not," says Alan Snyder, a San Francisco money manager.
Snyder, who usually buys value stocks, has taken a recent shine to gold. But even he says investors should not have more than 5 percent of their assets in gold. "It's like an insurance policy. You buy a fire insurance policy on your house and hope you never have to collect on it."
Snyder likes gold mainly as a hedge against global political risk.
The price of gold surged from roughly $278 per ounce in January 2002 to $382 in February 2003, during the buildup to the war in Iraq, then lost steam, slumping to $321 in early April.
The conventional wisdom was that when the war ended, gold prices would collapse. But that didn't happen. Gold rocketed up to $371 in late May and is currently trading around $357 per ounce.
Snyder says that's because geopolitical problems still loom large, especially in populous regions like China, Korea, Pakistan, India and the Mideast, where people "have been brainwashed for millennia to trust gold during times of uncertainty. You can bury it in the backyard, carry it across borders."
Other managers see gold as a hedge against financial, rather than political,
uncertainty.
"Gold is a long-established monetary asset that represents an alternative to paper money," says Jim Grant, publisher of Grant's Interest Rate Observer.
"It is an off-and-on safe haven against many financial disasters, including bear markets, currency devaluation, rising domestic inflation rates and the like. Gold is a hedge against monetary disturbances."
Gold is also said to be a "store of value" that holds up better than financial assets during periods of deflation and rampant inflation.
During the last bout of hyperinflation, gold soared from about $35 per ounce in January 1970 to a short-lived peak of $850 in January 1980.
The Fed's successful war against inflation sent gold into a 20-year tailspin, from which it only recently has begun to recover.
Gold's recent revival has many possible reasons.
The conflict in Iraq certainly had some impact, as did the falling dollar, falling interest rates, falling stock prices and corporate fraud -- all of which made gold relatively more attractive than stocks and bonds.
If the economy worsens, gold likely will remain attractive relative to financial assets.
"If we have real deflation, things will start collapsing here and people will go to gold," says Richard Russell, publisher of Dow Theory Letters.
The last time the United States suffered deflation was during the Great Depression. At that time, foreign holders of dollars could exchange them for gold at a price set by the U.S. Treasury.
In 1933, to restore faith in the dollar, the government raised the price of gold from $20.67 to $35.
"Holders of gold stocks in the early '30s were unique in that those stocks did not go down," says Grant.
Some gold lovers say that proves gold does well during deflationary times. But things are much different today.
In the early 1970s, President Richard Nixon severed the link between gold and the dollar. That ended dollar-gold conversion and set the dollar and gold prices free to float.
Grant says he's not sure whether gold would be a good hedge against deflation today. But he's not really worried about deflation. He's much more worried about inflation.
"The fear of falling prices is spurring the Federal Reserve to create lots of credit, which may provoke a new cycle of rising prices. Or it might scare foreigners out of the dollar and provoke a cycle of a depreciating dollar exchange rates. In either case, gold may be a beneficiary," Grant says.
So there you have it. Gold could do well if we have deflation, hyperinflation, a dollar that won't stop falling and/or continued geopolitical uncertainty.
On the other hand, if peace breaks out around the world, if the U.S. economy and the dollar recover, if deflation fears subside and inflation can be kept in check, gold would become less attractive.
On Friday, we'll take a look at the various ways to buy gold.
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