Gold Running on Fear

11/24/2011 3:00 pm EST

Focus: COMMODITIES

James Stack

President, Stack Financial Management

Gold is running higher on psychology, says long-term bull Jim Stack, but he thinks the current fears are overdone, and if the economy gets stronger, those late buyers may get a real shock.

Well, Jim, you’re not exactly known as a gold bug.

Actually, I have been a gold bug in the past. In fact, there are very few periods in history between the early 1980s—when I started the business—and about three years ago when we did not have gold stocks in our portfolio.

So you’ve owned gold for quite a while.

Yes, very much so.

Having said that though, I mean we’ve seen gold hit really record highs, up to over $1900 an ounce, and it seems…especially tied to some of the debt crisis going on, a lot of fears of that, people running away from what they call fiat money into gold. When you look at gold now, what do you think?

Well, Howard, I’m still a gold bug. Gold is the ultimate defense against both currency devaluation and inflation. It’s the only hedge against both of those, against the falling dollar or inflation going up to high levels.

The problem with gold is the valuation, what it’s valued at today. Those two factors, both inflation and currency, determine the intrinsic value of gold.

Now, if gold was valued at all reasonably throughout the 1990s and even in most of the past ten years…up until the last four years, if you factor in—and we’ve done the mathematical modeling on this—if you factor in how much the dollar has fallen and how much inflation has gone up, the true intrinsic value of gold today would be between probably $600 and $700 an ounce.

Does that mean we’re in a bubble in gold? No one knows. Bubbles do not become apparent, particularly to those inside the bubble, the believers of it, until after the bubble pops.

The problem with gold is it’s running on psychology, its running on fears—fears of the deficits, fears of the debt, and fears of the ultimate default. Now if we go out ten years and the US does go into default, does go into an economic calamity, then gold may seem cheap at $1,700 today.

If not, if this recovery is not going back into a double-dip recession, then over the next 12 months we could see that psychology in gold suddenly reverse, and I think holders or the latecomers to gold could be hurt very badly. We could see gold, I think, drop by 30% or even under $1,000 an ounce in the next two years if the economy does start picking up in what would be called a more normal, recognizable recovery.

Well, I think it was about $1,100 to $1,200 an ounce back in 2010, before the takeoff with QE2. One question I have is how can people say gold is good when there’s inflation, and they like it when there’s deflation too? I don’t see how both things work together.

Theoretically, gold is a protection against both economic collapse and hyperinflation.

Currency collapse.

Yeah, currency collapse. In the 1970s gold did very well, $32 an ounce up to $850 an ounce in the first quarter of 1980. I remember that psychology well. Everyone thought it was going to $2,000 an ounce, and that was a peak that we didn’t see surpassed until the last couple of years.

And it still hasn’t been surpassed with inflation.

Inflation adjusted, it hasn’t been surpassed.

If you talk about deflation, here’s the problem with gold on a deflationary basis: yeah, gold did well in the 1930s, but initially going into the 1930s—from 1929 down to about 1931—gold collapsed, the price of gold collapsed right along with the stock market. so gold is not really the ultimate deflation hedge…it’s just a place that people tend to flock to when they’re seeking a safe haven.

A lot of the safe-haven seeking in gold right now really comes from the fears of the deficits and possibly default. I think to a great extent those fears are overextended, and if they are overextended, I think there’s a lot more downside risk than upside potential in gold.

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