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The price of gold has been on a tear recently, surging $25, to $305 per ounce, as investors seek a haven from a variety of worries, including Argentina's debt default, Japan's shaky banking system, and Enron-fueled stock market woes in the U.S. Especially now, in the aftermath of the Enron disaster, investing in gold has an elegant simplicity: You don't need a congressional hearing to decipher its balance sheet or income statement. It's worth what the market says it's worth.
Gold is by nature a cyclical asset, though its appeal as a hedge against inflation had dimmed in the '90s era of waning price pressure. During that period, the market value of the precious metal has been in a relentless downdraft, falling from a high of over $462 per ounce in 1990 to a low of $251.70 on Aug. 18, 1999. But gold's long losing streak may finally be at an end.
Along with the gradual recovery in the U.S. economy, a combination of aggressive monetary and fiscal forces may set the stage for higher inflation ahead -- boosting gold's appeal. The Federal Reserve's 11 rate cuts since January, 2001, have pumped massive liquidity into the U.S. financial system. And President Bush's fiscal 2003 budget signals an inevitable return to deficit spending, though the shelved U.S. stimulus bill and the global lack of pricing power should help temper inflationary forces ahead.
Add to this the increasing nervousness about the health of world economies and banking systems, and jittery investors could once again pile into the perceived safety of gold.
A PREMIUM ON SAFETY. The list of concerns that could drive gold's price even higher is daunting. Corporate defaults reached record levels in 2001 and despite signs of an economic recovery, are on pace to break that mark in 2002. Argentina defaulted on its sovereign debt, and its banking system has plunged into chaos. Japan is in the grip of deflation, and its banking system is coming under increasing pressure. (Indeed, recent press reports indicate that worried Japanese investors have been buying gold bars.) The latest worry: the viral spread of accounting irregularities among previously high-growth energy and telecommunications companies.
These events can only enhance gold's safety premium. Sure, its investors have been burned before -- the price has run up sporadically in recent years, thanks to short squeezes, only to drift back down again -- and recent gains may be just another such flash. But some fundamental signs suggest that the metal's latest comeback could prove more durable.
The past decade was brutal for gold bugs. In the late '90s, even central banks, spurred by budget surpluses and monetary union in Europe, opted to pare down their stockpiles -- among the biggest in the world -- and lend out reserves for a nominal return of 1% to 2%. And gold producers themselves seemed to put little apparent faith in the market's value of their stock-in-trade. They have been utilizing vast and complicated forward-hedging schemes -- through the derivative markets -- to lock in a price for their output. In fact, as demand exceeded their production on occasion, producers found themselves caught short -- needing to purchase some of the gold required to satisfy their hedges. Now, they may be in line for a reversal of fortune.
ECONOMIC MIRROR. Buy-and-hold gold investors are ready. They've always been a hardy breed, willing to forego interest or dividends -- and incur storage costs -- for the perceived benefit of security and the possibility of price appreciation. Gold-mining stocks, which hit record highs recently, are probably a more efficient way of investing in the metal (as opposed to, say, storing several thousand ounces in your basement). But they can be subject to company-specific country or political risk -- with mining giant Freeport McMoRan's recent misadventures in Indonesia being the most recent example.
Gold is at best only a loose proxy for the economic cycle and market instability. The classic insider's asset, the precious metal is costly to hold and subject to impulsive, volatile price moves -- and supply-demand dynamics that are often mystifying, even to market veterans. So while a new golden age may indeed be dawning, investors lured by gold's recent ascendancy would do well to remember those caveats.
Wallace is chief market strategist for S&P/MMS International Edited by Beth Belton
Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
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