Don't Give Up on Gold Just Yet

04/23/2013 10:15 am EST


Axel Merk

President and Chief Investment Officer, Merk Investments, LLC

Despite all the negatives, gold...and currencies...continue to offer the most impressive opportunities to investors, says Axel Merk of Merk Investments

The negatives with regard to gold?

First, China’s GDP growth has slowed to 7.7%, ushering in an era of more modest growth. In the past, disappointing growth numbers out of China have on occasion been a negative for the price of gold, as well as broader “risk sentiment.”

Second, as European Central Bank (ECB) President Draghi recently pointed out, the reason the ECB isn’t printing more money is because other central banks have shown that it doesn’t work.

Indeed, we have pointed out many times that the biggest threat we might be facing is economic growth. That’s because once the money that’s been “printed” starts to “stick,” deficits start to matter, as bond markets throughout the world might sell off.

Third, the Eurozone has not fallen apart, and rampant inflation has not taken hold. As such, it’s only reasonable for gold to take a breather.

Fourth, there’s a lot of “exit” talk at the Federal Reserve, with even doves calling for a phasing out of purchases toward the end of the year. Much of this talk might be wishful thinking.

Surely the Fed would like to go back to a more normal environment, but recent disappointing data—such as disappointing non-farm payroll and retail sales reports—show that such talk might be premature. Still, forward-looking markets might start to price in that “at some point,” there may be an exit from the highly accommodative monetary policy.

In the past, we have cynically indicated that there’s never been a Eurozone crisis. Instead, there’s a global crisis. Taken together, there are plenty of reasons to believe that we haven’t seen anything yet with regard to the price of gold—and with that, we mean on the upside.

However, investors were reminded of the fact that gold is historically rather volatile, even if recent volatility is on the high side—even by historic standards. We also have to keep in mind that a lot of technical damage has taken place. Many investors who bought gold in the past two years have paper losses and might be eager to sell on rallies.

From our point of view, volatility is your friend. It shakes out weak holders of gold, making price appreciation ultimately more sustainable.

The recent volatility in gold does raise a broader concern: It appears there are fewer and fewer actors in the markets, with trading ever more driven by computer models and hedge funds. Reduced liquidity makes for rocky markets.

On that note, don’t think for a moment that there is a place to hide. As we have indicated many times in the past, there may be no such thing as a safe haven anymore. In holding US dollar cash, one’s purchasing power may be at risk.

But holding gold is certainly not “safe” either, if you value your holdings in dollar terms rather than by the amount of troy ounces held. Central banks have addressed this challenge by diversifying to baskets of currencies, including gold. Investors should not trust that their government will preserve the purchasing power of their currencies for them, but may want to take a more active approach.

We happen to like currencies—and I shall group gold into this as the ultimate hard currency—as they carry no equity risk, and typically low interest and credit risk. As such, in a volatile world, currencies and gold allow one to take a direct position on what we call the "mania" of policymakers.

We may not like what policymakers are up to, but we think that they are rather predictable.

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