October 02, 2010

How Much Further For Gold?

You’ve read the news, Gold at $1320 this week and the analysts are beating each other over their heads as to where the next gold target might be.  We heard everything from $1,500 to $5,000 within a few years.  All that accompanied with the ongoing debate as to whether we will see continued deflation, inflation or possibly hyper-inflation.  So what’s it going to be then?

The short answer is: “It depends”. Let’s forget about semantics for a minute however, and look at the general cost of living and the cost of running a business.  There are a myriad of factors influencing the overall cost of running your life or your business.  The best assessment of a sort of felt-inflation is a comparison of the overall cost of living with your income.  In that sense, on a macro level, the majority of consumers have experienced a significant rise in the cost of living, felt-inflation if you will...

To some extent, that is reflected in the rise of some commodities and most notably in the form of the run on gold which appears to be gathering pace as we speak.  Is Gold then the panacea for each of the dreaded outcomes in terms of a protection against deflation AND (hyper)inflation?


In his Investment Outlook October 2010, Bill Gross concludes that:

The most likely consequence of stimulative government policies that strain to get us there will be a declining dollar and a lower standard of living.

If you (still) have a job, that lower standard of living might not be obvious just yet.  But the current decline in the value of the Dollar has been gaining pace, despite efforts by some countries (Japan, Brazil) to slow down the rise of their currencies against the Dollar.


While the Gold bulls are tooting their horns, we cannot ignore the fact that a big part of the recent rise in the gold price has been the declining US Dollar.  That is apparent when valuing Gold in Euro...


even more apparent when valuing Gold in Australian Dollars...


The massive gains in Gold are no longer as profound in other currencies which reflects the decline in the purchasing power of US denominated investors. 

Taking nothing away from the incredible bull run in Gold during the past decade, we need to put things into perspective though. An investor faced with uncertainty may seek some relief in Gold.  From a safe-haven perspective, Gold has been a good hedge against uncertainty and its most dreaded symptom deflation.  The historic inflation record of Gold is somewhat mixed but if official inflation were to resume, the majority of Gold bulls will seek exactly that hedge against inflation by shifting more of their depreciating cash assets into a real asset. 

Having said that, one must consider the possibility that the continued rise in Gold will be less pronounced when valued in other currencies.  From an investment perspective the Australian Dollar could be a good alternative to Gold in terms of a hedge against the decline of the Dollar. While both the Australian Dollar and Gold can be similarly volatile, there is an added advantage favoring the Aussie.  The yield differential against the US$ is about 4% which beats Gold, a non-yielding asset.

However, whether you invest in the “real” currency Gold or in a paper currency such as the Australian Dollar, do not underestimate the volatility both of these currencies can experience.  As always, carefully evaluate the risks before investing.

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