Gold-Diggers

Gold is the great inflationary predictor, and holding gold is a superb hedge against rising prices, recession, and bear markets. A wonderful asset to hold in times of economic trouble.

Or so goes conventional wisdom.

Gold is on the rise, with a recent six week run upward, and now sits over 7.5% higher this year in USD and boasts a similar return in Euros.

Price movement in gold is extremely difficult to predict, and we'll venture no such forecast here. But a discussion on the fundamentals potentially moving gold is worthwhile because the data show gold's status as an inflationary indicator could be on shaky footing.

Traditionally, gold tracks TIPS (Treasury Inflation Protected Securities) fairly closely and is a reliable predictor of rising prices. Most all of the mined gold in the world is still in use. We don't transform it into anything and we don't dispose of it once we've used it. We hold on to it. China and India are examples of nations with increasing wealth that have a cultural propensity to save via gold. Gold can be a great store of wealth and a big reason many governments used to (and some still do) back their currencies with it. Investors can flee to the yellow metal when inflation's eroding effects threaten to decimate asset prices.

But this relationship has broken down recently. Inflation continues to be tame and yet gold's strength remains. Meanwhile, the bull market in stocks charges onward. It's unfathomable to many, but recently gold's had a relatively high positive correlation to the stock market…a hedging instrument this is not.

The problem with thinking about gold as a purely economic indicator is that it's also a commodity with many real world uses. In addition to the central banks of the world hoarding it away in musty vaults, gold is also used in significant quantities for industrial purposes and jewelry.

This makes gold subject to the traditional economic pressures of supply and demand. The supply of gold is relatively fixed and predictable. The growth in output from mines throughout the world is fairly consistent and the possibility of an unexpected flood in supply to the markets is very low because new mines are difficult to discover and build.

As the global economy continues to grow it's possible gold prices are being pushed up by higher demand. As nations get wealthier, they will demand more gold for all its uses. Demand outstripping supply could very well be the reason gold is strong…not impending inflation. We continue to believe TIPS spreads are a more meaningful indicator for inflation…and that inflation fearers are gold-digging for a reason to worry.