Thursday, July 28, 2011

Investing in Gold: An irrational exuberance? - Forbes (blog)

It is official: gold is an asset–a store of value, as chairman Ben Bernanke explained to Senator Paul Ryan. But how good of an asset is it?

It depends on two factors: First, on the prospect of economic outlook, especially on inflationary expectations—gold is a hedge against inflation. Second, on how bad other assets, such as stocks, bonds, especially those denominated in dollars that has been falling like a stone, since the Federal Reserve launched its two rounds of Quantitative Easing; and on how bad assets of heavily indebted countries like those of Southern Europe—gold is a hedge against sovereign debt risks.

It comes as no surprise, therefore, that investors around the globe have been reaching for the shinning metal to add some luster to their portfolio—sending its price soaring. SPDR Gold Shares (NYSE:GLD), for instance, has gained 20 percent in one year, 50 percent in three years, and 100 percent over five years—with analysts coming up with all kinds of wild guesses, 2,000 by the year’s end and 5,000 within the next three years!

Does it sound familiar? Remember predictions about Dow 20,000, 30,000 or 50,000 in 2000? Investors who buy gold as a hedge against sovereign debt, should be reminded that governments have the power to cut spending and raise taxes—it is called fiscal austerity; and credit markets will force them to do so, whether citizens like it or not, as has been the case throughout Europe. Credit markets will further perform what central banks aren’t willing to perform, unwind quantitative easing, pushing long-term rates to the levels where they should be given the size of sovereign debt—it is called monetary austerity. Politicians may lose elections, central bankers may come and go, but institutions won’t collapse.

Investors who buy gold as a hedge against inflation should be reminded that fiscal austerity and higher long-term rates will push a weak world economy into stagnation, even a recession that hardly provide a bullish scenario for gold.

The bottom line: Gold isn’t an asset for all seasons. When financial analysts argue so, it is time for prudent investors to stay on the sidelines or even take the other side of the trade.

Disclosure: Short on Gold

View the original article here

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