Can Gold Stand the Heat?

04/26/2011 3:41 pm EST

Focus: COMMODITIES

James Stack

President, Stack Financial Management

The unprecedented gold run has come during an equally unprecedented economic recovery, one for which the market norms might not apply the way we expect them to, so buyer beware, says James Stack of InvesTech Research in this exclusive interview with MoneyShow.com.

We’ve got a lot of things percolating here. Overall, we’re seeing global food prices rise, we know what’s going on with oil—and of course gold is off the chart. Are natural resources and commodities a good investment?

Well they’re pretty frothy right now.

Here’s what’s unusual about this economic cycle: We’re not even two years into this economic recovery, since the recession officially ended in June of 2009.

Normally, commodity prices don’t start hearing up until you end up in a maturing recovery—one that’s in its fourth or fifth year. We’ve seen commodity prices come back much sooner and much more heated than we’ve seen in past economic recoveries.

That’s a concern, because if there’s an Achilles’ heel to his recovery—which is on pretty firm footing right now—it’s going to be that inflation pressures that could start appearing or turning worse by the end of 2011, or going into 2012.

Again, when you look at commodity prices, it’s not that they’re a bad investment, they’ve just been run up too far, too fast...and they’re pretty heated.

Gold is a perfect example. Everyone loves gold. It’s a perfect hedge—but that’s the same as saying that you can’t lose money in real estate. That worked until about three years ago.

Gold, just a decade ago, was under $300 an ounce; today, it’s $1,500-plus an ounce. We can say it does that because of inflation, or because of the falling dollar. But if you take out the effects of inflation, take out the falling dollar, and look at gold adjusted for both of those over the past ten years, gold has still gone from under $300 an ounce to over $800 an ounce.

That’s almost a tripling in value, and I don’t like going out and paying just any price for an underlying asset. Even something that I like as much fundamentally as gold...I don’t like overpaying for that asset.

Looking out over the next 12 to 18 months, the downside risk in gold is equal to, if not greater than, the upside potential—and that’s what concerns me.

If you were to see a drop in prices of gold, say beneath $1,000, would you buy it?

Yeah...And I think that’s very realistic that we might see it, once the froth cools and everyone starts battening down the hatches and pulling in those profits. That's what happens when it gets too frothy and frenzied. Everyone heads for the exit to pull in those profits and it drops very quickly.

If gold drops under $1,000, we’ll definitely be looking at it.

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