As of Late, Gold Is Behaving Like an Actual Commodity

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The New York Sun

The enthusiasm of gold bugs is lately justified as traders pushed gold prices north of $500 an ounce this week with several consecutive record sessions. The spot price yesterday jumped another 1% to $519 an ounce – the highest level since 1981 and ahead 18% so far this year.


Normally gold does well when everything else is falling apart, but over the past year gold has behaved like a normal commodity, moving higher in price as demand has increased. No commodity can be discussed without talking about China, and indeed it has become a major “new” source of demand as its developing middle class, now numbering between 200 million to 300 million, has acquired a taste for jewelry. A prosperous India, too, has upped its consumption. India is actually the world’s largest consumer of gold.


Gold prices have increased even while the dollar has been strengthening, which suggests that the metal is being bought not only by those who are pessimistic about the American economy or the dollar. Lately, momentum players have pushed up the price, but certainly the fundamental underpinning has many components.


However, there are those like Axel Merk, manager of the Merk Hard Currency Fund, who are investing in gold because he is not happy with the outlook for the American consumer, the economy overall, inflation, or the dollar. Mr. Merk is not someone to talk to if you want to get into the holiday spirit.


He describes his fund as targeted at people who are concerned about a drop in the value of the dollar. His reasoning is that the American consumer, upon whose stooping shoulders the economies of the world rest (that’s not exactly how he put it), is nearly worn out.


He points out that consumer spending has not hit a pothole in more than a decade and is overdue for a slowdown. Fiscal and monetary policy has shored up the consumer, with tax cuts and low interest rates, and cheap imports have fueled spending. Coming up, in his view, is the perfect storm, with rising interest rates, changes in credit card rules that will mean higher required payments, and the impact of higher energy prices suddenly taking effect in the first quarter.


Mr. Merk views the consumer today as unusually sensitive to interest rates. While Americans have been taking on increased debt over the past 20 years, interest rates have trended lower. Now, the reverse is true.


Mr. Merk thinks that the incoming Federal Reserve chairman, Ben Bernanke, is going to face a slowing economy as well as rising inflation. Though price hikes have so far been masked by cheap imports from Asia, Mr. Merk points to increasing producer price levels as evidence that inflation is creeping into the numbers. He asserts that if prices don’t go up due to consumer resistance, corporate profits will take a beating. That won’t be good for stocks, either.


Mr. Merk’s response? He thinks bonds are vulnerable to rising rates, that real estate and many stocks are expensive, and that holding dollar-denominated cash is not an option. In his view there is every possibility that at some point foreign governments will shrink from their ever increasing purchases of dollars, as they perceive the American economy to be sputtering or as trade friction grows.


Instead, he prefers investing in hard currencies, which he defines as those of conservative governments and, currently, those of countries riding a propitious commodities cycle. Specifically, he is holding substantial amounts of the Australian dollar, the Canadian dollar, and gold. Interestingly, he does not hold the Japanese yen.


The economies of both Australia and Canada are skewed toward gold, other metals, and other commodities, including oil. Driven by profit growth in those sectors, the exchanges of both countries have outperformed the S&P 500 by a wide margin this year. The Australian market is up about 14% while the Toronto Exchange is ahead by 20%. The S&P 500 is up only 3.6%.


Mr. Merk was born in Germany, educated at Brown University, and has worked in the financial communities of both Europe and America. After receiving a degree in computer science, he started a money management business in Switzerland.


Ultimately, he began to focus on currencies and started his Hard Currency mutual fund in May of this year. Despite his positive instincts, his fund, which is still quite small, is down slightly this year. He maintains that he has outperformed funds with a similar mandate. He is investing in money market instruments of various currencies, as well as gold (through ETFs) and some derivatives products. His expenses are low, capped at 1.3%.


It may be that Mr. Merk is swimming upstream. Though many market observers expect some increase in inflation and slowdown in growth, they are optimistic about improved stock market performance next year. One positive factor is the sizeable cash balances on corporate balance sheets and renewed activism among shareholders, which could spark continued share buybacks and acquisition activity, boosting stock prices.


The various notable money managers of Legg Mason, for example, who spoke to a gathering yesterday in New York, are unanimously bullish on American stocks in 2006. William Miller, who has outperformed the market with astonishing consistency, considers the market to have been weighed down this year by oil prices and rising interest rates. He is confidant oil prices have peaked for this cycle, with the $60 a barrel price more than covering the $40 marginal cost of production and a premium adequate to compensate for a litany of geopolitical risks.


He is also expecting that the Fed is near the end of its tightening program, and that when a leveling off is indicated the market will stage a sizeable rally.He notes that corporate earnings growth has been excellent and that price/earnings multiples have been compressed. Even as growth slows, multiples should expand with a brighter interest rate picture. He thinks the best value is in many of the traditional growth stock groups, singling out financial and technology stocks as especially attractive.


This time next year, we will know which of these camps proves correct. For the present, I know which forecast I want in my stocking.


The New York Sun

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