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Gold Traders May Have to Rethink the Sovereign Risk Appeal

Gold Traders May Have to Rethink the Sovereign Risk Appeal

2010-05-15 02:54:00
John Kicklighter, Chief Currency Strategist
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In the past few months, gold has taken up a new calling. Acting as a safe haven in turbulent times is a given fundamental role that even the most novice traders are aware of. On the other hand, the asset’s function as an alternative to traditional fiat currencies is a concept that is not as frequently touched upon. Yet, with Greece on verge of default, this role is becoming more and more prominent. The trouble over whether the EU can prevent unacceptable deficits from turning into double dip recessions, civil unrest and squabbling over how to raise the necessary capital to fund the promised life line are all raise an immediate threat to the stability of the global financial markets and thereby leverage the need for safety outside the bounds of a traditional economy’s assets. Gold is that asset. And, when we move beyond the pressing issue of Greece and the EU; we are still met with doubt for the traditional safe haven assets (Treasuries). Government deficits have surged to records for most of the major industrialized economies. Should sentiment rile the markets, the impact on growth will make it extraordinarily more difficult to reduce deficits. No matter which way we look at it, there seems a fundamental support for gold.

However, this argument is too simplistic. Suggesting gold is a perfect alternative to currencies is missing a few vital points. First, this precious metal is a limited resource. With a currency, a Treasury can increase or decrease the money supply to meet demand. When it comes to gold, the set supply means there is a chance for manipulation and simply a leveraged response to buying and selling. In the end, gold cannot be used to purchase everyday goods or most assets. Should there be a general desire to diversify or redistribute wealth, it could have an outsized effect on gold’s price. Furthermore, as its own store of wealth, gold is already extraordinarily expensive. There is no yield to be found in holding the metal; so investors will have to hope that it will at least hold steady to protect funds or appreciate to make some level of return. Given its leveraged nature and sensitivities to liquidity, losses could come quickly. At some point, rational investors will recognize there is substantial risk in holding gold as a safe haven. That time may already be now since it is at a record high. To press further appreciation would take significant inflows and that is likely to only come during times of fear-induced investing or panic. It is by nature of probabilities that these are unusual circumstances. Given the ‘costs’ of this safe haven, I maintain a cautious bullish bias on gold. It is not a buy and hold at record highs; but it could still offer short-term opportunities. - JK

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