Gold: Lower Prices May Offer Spot To Build Hedges

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Gold has fallen back below the $1400 level as both the dollar and stocks shrugged off the latest weak economic data. The dollar index is engaged in a test of last July's high at 84.10. Penetration would put the greenback at new three-year highs.

Both the DJIA and the S&P 500 pressed on to new record highs in early trading, despite a decline in industrial production in April and a surprise drop into negative territory for the Empire State Index. Both data points were well below market expectations and are indicative of persistent sluggishness in the economy.

Additionally, PPI registered a second consecutive monthly decline in April, dropping 0.7%. This is just the latest indication of deflationary pressures, coming on the heels of yesterday's reported drops in both April import and export prices.

While the absence of inflationary pressures diminishes the appeal of gold as a hedge against price risks, deflationary pressures increase the likelihood that global central banks will push back all the harder in their efforts to manufacture the inflation they so desperately desire. The velocity of money is a funny thing though, if the inflation dam finally breaks, the central banks may get far more than they bargained for. Certainly the prospects for the Fed starting to scale back accommodations would have to be considered lower in light of today's data.

In the meantime, remember that gold has historically proven to be an effective hedge against systemic risks and deflation as well. Just look at the yellow metal's performance during the Great Depression of the 1930s and the more recent Great Recession of 2007 through 2009.

There seems to be this growing perception that the U.S. economy is improving, which is weighing on gold's more general safe-haven appeal. While there have been some bright spots on the jobs and housing fronts of late, the broader data simply don't bear out the notion that the economy is finally reaching 'escape velocity.'

All I can deduce then is that the perception is being driven primarily by the gains in the stock market. Assuming that all must be well simply because stocks are on the rise is ill-advised, as evidenced by the fact that the DJIA last peaked in October 2007 at 14,198, right before all hell broke loose.

Risk appetite too is a funny thing: Here today, gone tomorrow. In pushing investors out along the risk curve, the Fed is toying once again with peoples' financial futures. Particularly those at or near retirement, who would traditionally be invested largely in the (perceived) safety of fixed income products.

However, the near-zero yields of such products prompted Bill Gross of bond giant PIMCO to say, "Never have investors reached so high in price for so low a return. Never have investors stooped so low for so much risk." Given that reality, older investors and pension funds are jumping back into the stock market with both feet. What could possibly go wrong?

The plunge in stocks during the financial crisis is still very fresh in investors' minds, it strikes me that they would be very unlikely to ride out another 50%+ decline in shares. That may in fact lead to a more precipitous drop in stocks if those investors become concerned about the sustainability of their gains and start moving to the sidelines.

Maintaining your hedges may now be more important than ever. In fact, the lower price of gold could be viewed as an opportunity to either begin building those hedges, or bolster your existing hedges.


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About the Author

Peter Grant is Chief Market Analyst at USAGOLD. He has spent the majority of a career that spans more than 25-years as a global markets analyst. He began trading IMM currency futures at the Chicago Mercantile Exchange in the mid-1980's. In 1988 Grant joined the prestigious market analysis firm, MMS International. MMS was acquired by Standard & Poor's a short time later. He spent twelve years with S&P - MMS, where he became the Senior Managing Foreign Exchange and Precious Metals Strategist. The financial press frequently reported his personal market insights, risk evaluations and forecasts. Prior to joining USAGOLD, he served as VP of Operations and Chief Metals Trader for a Denver-based investment management firm.

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