- Created on Monday, 04 October 2010 15:41
- Written by Sara Nunnally, Editor, Smart Investing Daily
- Hits: 2342
My co-editor Jared Levy and I were sitting in the audience at this year's 2010 Global Opportunities Summit in Las Vegas when gold hit a new record... Futures prices topped $1,300 an ounce, and Jared turned to me and said, "Now's the time to take some profits off the table."
Friday saw gold for December delivery hit $1,319.70, another record, and traded as high as $1,322 at one point during the day.
So what does this mean? Are gold prices too high? Will we see a correction?
Or will gold continue its climb, and possibly hit $1,500 an ounce by the end of the year, as one analyst writes?
I like gold, nearly at any price, for one specific reason: It always makes sense to allocate some portion of your investment portfolio to this precious metal, and hold it as a hedge against both currency and stock market fluctuations.
But traders might see a different picture.
Is the Gold Market Overheating?
Traders might look at how gold prices have climbed 12% in the past 60 days, shooting nearly straight up from late July. Take a look at this Kitco chart:
In the four months prior to this huge bounce, gold prices showed a lot more back and forth, ending the four months with a gain of only 5%.
This move is massive, and now we have to determine if the gold market is overheated. And for that, we have to look at exactly what's driving this market higher, and if those factors are still in place to make this a long-term move.
The main factor behind this move is the strength of the U.S. dollar. Take a look at this U.S. Dollar Index December futures chart that compares the dollar to a basket of currencies:
This six-month chart from Barchart.com shows the dollar in a massive decline since early June. It's this drop that's propelling gold prices higher.
The Federal Reserve has been talking about more quantitative easing, which spells more trouble for the dollar. If the Fed cuts rates, gold prices could indeed hit $1,500 before the end of the year. This is a big, big decision that's waiting on some key economic figures coming in the next week or so.
The Fed has clearly stated that it's ready to "take further action" if the U.S. economy fails to show any strength. The next meeting is in November.
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Inflation and Gold Prices
In the long term, it's clear that the Federal Reserve's monetary policy will lead to spikes in gold prices that we haven't seen since perhaps the 1970 s when we lost the Gold Standard. Gold prices climbed from $37.87 in January 1971 to $183.85 in December 1984... an incredible climb of 385% in four years.
In 1971, inflation stood at 4.3%; 1972, the figure fell to 3.3%. Then in 1973, inflation popped to 6.2%, and in 1974, inflation soared to 11%.
This shows you that when inflation hits, as it surely must with the Fed keeping rates at near zero and printing money like mad, it hits hard and fast. The dollar drops and gold skyrockets. We see the same thing in the late 1970s and early 1980s with inflation at 11.3%, 13.5%, and 10.4% in 1979, 1980, and 1981 respectively.
Gold prices went from $227.27 in January 1979 to $410.09 in December 1981, topping $675 an ounce in January 1980.
What to Do in the Meantime
But in 2009, inflation was -0.4%, and 2010's inflation is estimated to be 1.4%... That's hardly scary compared to what happened three decades ago.
What are we supposed to do in the meantime? Heck, what are we supposed to do in the next four months?
Craig Ross, vice president of ApexFutures.com in Chicago, told Kitco that gold would likely hit $1,325 an ounce this week, and that $1,350 wasn't out of the question. George Gero, senior vice president and financial consultant RBC Capital Markets Global Futures, told The Street a similar story, saying that gold's next resistance point was at $1,325.
Over the next few months, we could see continued demand from institutions, investors and regular folks who buy gold jewelry (though these higher prices do dampen jewelry demand, the fourth quarter is still a strong quarter overall).
Investment demand has really picked up, though. According to Gold.org, demand for gold jumped 36% in the second quarter compared to the same time last year.
And that's with gold prices at $1,200 an ounce!
Demand and price trends say the best time of year to buy gold is in the summer, but you might not want to wait that long.
If the Fed decides not to ease rates, we could see a slight pop in dollar strength, which could give you a momentary pullback in early November. That gives traders four weeks of possible price climbs and a potential exit point.
"Short term" buy-and-hold investors might buy and re-assess come the end of March 2011, while maintaining a prudent trailing stop.
Long-term investors, or folks that will buy now and hold gold in their portfolios indefinitely, will ignore the Fed's decision in February, and possibly average down in summer, should gold prices move against them.
Gold ETFs like the SPDR Gold Trust (GLD:NYSE) or the iShares Gold Trust (IAU:NYSE) are easy and accessible for both long-term investors and traders, as both have options. Of course, buying coins and bullion is also an option. Beware of gold mining companies, however, as costs can sometimes trip these stocks up even as gold prices climb.
If you're playing gold itself, or hedging your portfolio, the purer the play the better.
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