Gold: Chicken Little or Dr. Pangloss?

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May 4, 2011
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Our Investment Strategy Team is often asked if gold is still a safe bet despite its extraordinarily high price. At $1,535 per ounce, the price of gold has reached a 50-year high. However, our research suggests that there may still be more glitter to come.

Many investors ask about the safety of gold as an asset class because of the difficulties of evaluating its true worth; it pays no dividend, generates no revenue and even costs an investor to own. However, these difficulties vary little from those encountered valuing other asset classes. Even investments that have a calculable value may never actually sell at that value, because the price of an object – stocks, bonds, art, gold – is often driven more by expectations, fear and greed rather than an intrinsic value. Gold is no different except that determining the intrinsic value is more opaque.

We added gold to our client portfolios over a year ago for several reasons:

  • Concern about the continued debasement of paper currencies in the developed world
  • Rising inflation
  • Uncertainty about situations in Israel, Palestine, Iraq and Afghanistan (and now we must add other countries within the Middle East to this list)
  • European financial pressures
  • China and other emerging world central banks buying it as a reserve currency
  • As a hedge against too much optimism

We had no upside target, but we believed that gold would be in demand for a while.

With the price of gold up over 30% in the past year and 8% since the first of the year, we now face the Chicken Little/Dr. Pangloss conundrum. Will the sky (and the price of gold) fall, or like Dr. Pangloss, should we remain optimistic? Consequently, we are often asked when gold should be sold. Unfortunately, we won’t know until the time is right; by that I mean, we track a number of price trends that help us determine when the trend is rising, flat or starting to fall. We overlay that analysis with our outlook for interest rates, inflation, currency and commodity prices. We use all of the above factors in conjunction with our sense of investor uncertainty to decide when to sell. Right now we are still on the side of Dr. Pangloss and remain optimistic that prices will continue to rise.

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