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Some Thoughts On Whether Gold Should Be Bought Over $1,100/oz.

2 December 2009 3 Comments

Gold is starting to get more attention as it settles above the $1,110/oz. level.  The most common question regarding gold right now is whether it should be bought now or are you too late?  I’m going to lay out the potential scenarios that I think could happen, which ones I think are more likely to occur and what each means for the price of gold.

Stagflation

This ugly situation combines a stagnant economy with an inflationary environment.  This is definitely a disastrous scenario as it means high unemployment, stagnant wages combined with a deadly increase in the cost of living.  As you can imagine, this is a scenario our political leaders will want to avoid, but I’m not sure they’ll be able to.

Reflation

No matter what the leaders say, this is the course of action that is currently underway.  Our government (and governments around the world) are deliberately attempting to prop up failed economies or reflate the old economies.  Tax credits to reflate the housing sector, cash for clunkers, bailouts, etc. are all attempts to reflate the economy.

This scenario is very bullish for gold as government debt and creating money out of thin air help debase the currency and as a result increase the price of gold.  We will attempt to explain away the reflation/inflation as “economic growth”.  If the “growth” doesn’t materialize, the result can turn into stagflation.

Real Recovery

A real recovery is a bearish scenario for gold.  A real recovery, based on fundamental, strong growth would be bullish for our currency.  People want to hold our currency when they have faith in our economy and our fiscal position, thus the dollar would rise and gold decrease.

A real recovery would occur if businesses increase revenues, hire more workers and have increased profitability.  This growth is a real sustainable growth, as opposed to one time boosts by government stimuli.  Real growth actually decreases prices of goods due to innovation, increased productivity and competition.

Unfortunately, on a path of higher regulation, higher taxes, higher prices (gas, other commodities), and lack of consumer spending, I don’t see a real recovery.  A real recovery would have to first go through a painful restructuring of the economy where resources (workers, capital) are rebalanced towards productive industries and productive uses (move away from service sectors such as retail, home builders, mortgage brokers, etc.).  This restructuring would be a painful recession that is politically unacceptable.  Therefore, running the printing press and increasing the deficits in order to “fix” the economy is the chosen path.

Deflation / Depression

The last scenario that could unfold is a deflationary depression or severe recession.  I’m not sure if we’ll ever hit this since our leaders will probably destroy the currency before they allow this to settle in.  However, if a deflationary depression occurs, gold will likely take a hit as well (along with everything).

Interestingly, gold seems to hold up decently in a deflationary environment as well because of its status as a safe haven.

The Purpose of Holding Gold

I don’t believe in buying gold as a speculation.  I think the purpose of it is protection.  Protection from a devaluing of our currency.  If you’ve been responsible and saved a nice chunk of money, you are probably the person who should hold gold more than anyone.  You need to protect your cash.

With that said, I think anyone would be wise to hold gold, even people without many assets.  An increase in the cost of living could be partially offset by an increase in your gold holdings.

If you’re buying gold to protect yourself from inflation, I would recommend still buying gold north of $1,100.  If gold heads lower, it means your cash is worth more so you’re still ok.

An argument you will sometimes hear regarding why you shouldn’t own gold is that there are no fundamentals supporting an increase in the price of gold where stocks are fueled by earnings (real fundamentals).  I don’t think its a valid comparison because you hold stocks and gold for different reasons.  Again, gold is more of a protective asset.  Owning stocks are really owning businesses where you’re looking for cash flow (dividends or eventual capital gains).

Where Do We Head From Here?

If we continue on the path that we’re on, I think we could easily see gold $3,000, $4,000 even $5,000.  There are real deflationary forces in the market due to the massive de-leveraging going on.  My guess is that we will continue to provide “liquidity” until we’ve plugged all the holes left from insane levels of debt.  If we don’t, we’ll probably have a depression.  If we do, we will either have stagflation or reflation.   The debt doesn’t go away.  It just gets transferred to the public balance sheet.  The only way out from there is a devaluation of the currency – Cut the dollar in half and $20 trillion in debt becomes $10 trillion in debt.

Think about the choices for our leaders.   Higher taxes to pay for this debt is political suicide and hinders the economy.  Borrowing the money just increases our deficits and the public is becoming increasingly nervous about the deficit.  The only choice is the silent tax of inflation because it is less visible.  The is always the politicians choice.

If gold goes to where I think it could, it doesn’t matter if you bought gold at $800 or $1,100.  Therefore, don’t stress about buying at $1,100.  Remember why you are holding gold.  Remember it is an asset that isn’t at the mercy of political behavior.  With years of uncertainty ahead, go ahead and get in, even at $1,100.

EDIT: Since writing this article, gold has now gone above $1,200 / oz.  The upward trend continues.

3 Comments »

  • 20smoney (author) said:

    I'm working on another post about when to sell gold along with additional thoughts on when should you stop buying gold if it continues higher… as you mentioned, its definitely not the IDEAL time to buy gold… the ideal time was 10 years ago…. but there are still fundamentals in place for higher prices in my opinion… doesn't mean there won't be volatility along the way though..

  • 20smoney (author) said:

    Tom:

    Most "experts" say you should definitely have some physical gold, plus there are some concerns w/ ETFs such as does the ETF really have that gold in a vault somewhere? Also GLD is taxed at 28% i believe because its viewed as a "collectible". With that said, I dont own any physical gold, but I do own GDX, SLV, CEF.

    Gold is volatile. No doubt about it. It should be only a part of your overall strategy, don't put all your eggs in one basket. Accumulate gold (or gold related instruments) over time buying on dips.. I've read some people recommend as much as 30% of your portfolio in gold / gold related instruments. Then you can maybe break that 30% into thirds: physical gold, gold ETF, gold mining companies (stocks / ETFs)… just a thought…

    Also if you're looking to buy physical gold btu not hold it yourself, check out Goldmoney.com and places like the Perth Mint.