Gold Can Do No Wrong for Now

Wall Street Journal's Andrea Hotter explains how gold and been ever increasing in the past few weeks, constantly reaching new highs. Gold has been confirming its spot as a safety asset, when all other things have been falling in the market.

By Andrea Hotter
August 3, 2011, 9:20 AM GMT
Wall Street Journal Blogs

Another day, another high for gold, the commodity that can seemingly do no wrong—provided no other asset class does anything right.

The precious metal has hit yet another all-time high in early European trade Wednesday, of $1,673.19 a troy ounce, confirming its role as a safe bet when most other markets seems to be stumbling.

And how they are stumbling.

Although the U.S. is no longer encumbered by default fears following President Barack Obama’s passage of a bill raising the nation’s debt ceiling, the world’s biggest economy still faces the prospect of ratings agency downgrades, as well as contracting growth and the increasing likelihood of a third round of quantitative easing.

Eyes are now on Standard & Poor’s, which has adopted the toughest stance of all the ratings agencies against the U.S., and which has said it will consider its course of action by mid-October.

The threat of a downgrade alone will keep investors on their toes, and given that Washington’s deficit reduction deal falls a long way short of the “credible solution” that S&P had been seeking, a downgrade isn’t beyond the realms of possibility.

Michael Carey, a chief economist at Credit Agricole, said the impact of a U.S. credit downgrade could induce shocks to the economy which may lower next quarter’s real gross domestic product growth to near zero.

All of this is good for gold.

And let’s not forget Europe, which had taken a backseat while the U.S. took center stage of late.

Many of its economies are struggling to keep their heads above water, and the fiscal crisis is now damaging sentiment in the region’s core economies as well as in the periphery.

Jennifer McKeown, of Capital Economics, said that bailouts of smaller European countries like Greece might add to the pressure for the core governments, like Germany and France, to pursue their own fiscal tightening. This is likely to lead eurozone recovery to grind to a halt in the coming quarters as consumers stay reluctant to pick up the reins amid a further slowing in exports, she added.

Again, gold remains the obvious beneficiary.

It doesn’t look much better in the other major economies. Japan is growing a veritable mountain of debt, China’s politburo is walking the dangerous tightrope of balancing money and credit growth with inflationary pressure, and the emerging markets generally are feeling the knock-on effects of the deterioration in developed world growth.

Another gold star for the precious metal.

But if gold is ticking all the right boxes now, imagine what would happen is anything dramatically changed?

Already the U.S. is facing a necessary fiscal tightening which will be a drag on its economy for years to come, undermining industrial commodities like copper and steel, capping equities, and keeping a lid on interest rates and government bond yields.

But if the threat of the euro ceasing to exist ever became serious, or if the next round of U.S. debt talks later in the year failed and caused a government default and shutdown, gold would soar to levels that make near-$1,700/oz seem weak, just as $1,200/oz—seen only a year ago—appears low now. Calls to return to the gold standard would probably gather apace.

The point is, however unlikely these prospects may seem, anything’s possible. Lehman Brothers proved that no institution is too big to fail, and policymakers in the U.S. have just pulled the country back from the brink, for now at least. With the exception of the Swiss franc, the debasement of many of the world’s fiat currencies meanwhile continues.

The unthinkable just a few years ago could be just around the corner, leaving gold in an insurmountable position.

But imagine what would happen if things dramatically improved. If a cocktail of negative economic factors have combined to propel gold to its current levels, then the chances are a similar plethora of positive events would have the opposite effect. Wither then gold, if investors finally got the chance to put their money in other assets classes with confidence for the first time in several years?

This may not be a question to be answered in the near-term, but even the most bullish of gold bugs can’t be expecting the current Armageddon scenario to last indefinitely.

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