In this article I will summarize the main reasons why investors are reaching for gold. Despite the tremendous run up in the gold price to close to $2000, investors and speculators are still pouring into to Gold ETF's, bullion and even to a lesser extent, gold mining stocks.
First of all, real U.S. interest rates are negative. The whole curve up to the ten year bond is currently negative. Negative real interest rates are like steroids for gold bull markets. Today, the Fed is promising 0% nominal rates until at least 2013 (meaning negative real rates). Thus, the gold bull market will have these central bank steroid injections for several years.
Some investors fear that gold will crash and burn as it did in 1980. However, there are a number of key differences. First of all, Paul Volcker sharply tightened interest rates in 1979 and into the early 1980s (driving real rates positive. In other words, competence took over at the Fed and consequently gold peaked in January 1980.
Another difference between now and 1980 is the U.S. administration. In 1980, Ronald Reagan was running for President with a campaign for smaller government. Reagan also endorsed a pro-growth agenda that was business friendly with economic policies developed at the University of Chicago. Today we have President Obama unveiling stimulus plans and trillion dollar deficits loom as far as the eye can see. There's been a massive expansion of the Federal government bureaucracy and an explosion of federal regulations. Businessmen are being demonized.
Another key difference is that all central banks are now engaged in money printing. Most recently, the Swiss National Bank was added to the global print fest. Essentially, the last safe haven of financial assets has capitulated. No central bank wants a strong currency and that includes Switzerland, Brazil, China and Singapore. Every country is mindful of the Dutch disease and they do not want to hollow out the manufacturing or export sector of the economy. As people in the rust belt of the United States can attest - when the factory leaves, it never comes back.
While most look at gold as an inflation hedge, it is equally a deflation hedge. More importantly it is a hedge against quakes in the financial system. It is clear that the financial system in the "developed" world is on shaky ground. Starting in 2008, there have been countless banks that have closed shop in the United States. In Europe, even the IMF head, Lagarde views European banks as hopelessly undercapitalized.
In 1980, the world economies were dramatically different. Japan was on the verge of entering it's parabolic ascent. The German mark was a strong currency supported by a strong economy and a central bank that was ever mindful of hyperinflation. The U.S. was only nine years removed from the gold standard and there was vastly more initiative to reduce the size of government, tackle deficits and the difficult entitlement issues
Thus, until an investor sees the landscape change, gold is still a wise investment and the secular gold bull market rules.
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