Gold Is Flashing Warnings

Having hit a six-month high, the precious metal seems to be saying America's recovery isn't that great. Not everyone agrees, though

By Amey Stone

Gold is on the move again. On Oct. 20 it reached a six-month high of $425 an ounce in trading on the New York Mercantile Exchange, up from a 52-week low of $375 in May. Although the yellow metal is still below this year's April peak of $430, its recent climb is pointing to some troubling economic trends.

"Gold is a store of value when uncertainty is out there," says Michael Cuggino, manager of the Permanent Portfolio Fund (PRPFX ), which keeps about 20% of assets in gold. "It could be the pace of the economic recovery isn't that great," he says.

Stock investors seem to be coming to the same conclusion. The Dow Jones industrial average fell back below 10,000 yet again (it closed at 9,887 on Oct. 20) as Wall Street worries about less-than-stellar third-quarter corporate profits, rising energy costs, and declining consumer strength.


  Gold typically rises when stocks fall, which means it can help lower volatility. That's making it increasingly appealing, not only to speculators but also to long-term investors looking for a way to diversify their portfolio, says Frank Holmes, chief executive of U.S. Global Funds, which has several top-performing precious-metals funds.

The weak dollar, which fell to an eight-month low against the euro on Oct. 20 is also contributing to demand for gold by foreign investors and central banks. "Our positive view on gold is based on our bearish outlook for the U.S. dollar," said a Goldman Sachs research report in August that predicted gold would trade as high as $450 in the next six months. Increasing prosperity of Asian consumers, especially in China, is another factor behind the strong demand abroad.

"Whenever you see gold going higher and the stock market treading water or going lower, it indicates to me that people are looking for alternatives," says Ed Giobbe, president of ESG Capital Management in New York. He invests about 10% to 25% of client assets in gold. "Those trends tend to last a long time."


  Here's an important caveat to all this doom and gloom: The shiny stuff's higher price doesn't necessarily indicate that inflation is a problem and higher interest rates are on the way, say many experts. Indeed, rising rates present the biggest risk to gold prices, says Holmes.

Talk to Wayne Angell, a former member of the Federal Reserve Board who now has his own economic consulting firm, Angell Economics, and he'll tell you gold prices are actually declining -- relative to an index of other commodity prices, that is.

He doesn't think the Fed will need to raise rates to keep wages and prices in check. "Inflation isn't possible unless we get an increase in wages that enables workers to buy the products at higher prices," he says. "Clearly that hasn't happened." Pay is up just 2.3% year-over-year in the U.S. "Anyone that thinks inflation is a problem is simply out to lunch," he says.


  Holmes, too, believes interest rates won't go much higher, even if the price of gold continues to soar. "We believe rate increases will occur in a slow and measured way," he says, "so gold should continue to benefit."

That's not necessarily a reason to rush out and buy some bullion now. Giobbe believes gold could trade down short-term as some investors take profits on recent gains. He notes that commercial gold buyers are shorting the market, while financial speculators are buying gold. "That's a very bad combination over the next couple of weeks," he says.

Long-term, however, Giobbe believes gold will moving much higher -- to as much as $500 an ounce next year and potentially even $1,000 an ounce in two to three years. The best time to buy, he says, is on weakness. And with the price reaching a new six-month high while economic conditions in the U.S. wobble, weak isn't the word for gold right now.

Stone is a senior writer for BusinessWeek Online in New York