Gold Buying Opportunity and Hedge Against Uncertainty

By: Joseph_Brusuelas

Perhaps the most interesting development during the intensification of the credit crisis is that the price of gold did not climb higher than it did. Upon the initiation of the crisis in August 2007, the price of gold surged reaching a high of $1002.95 on March 14, 2007. Since then the cost of the precious commodity has fluctuated with the most recent price action sending it to recent lows of 725.74. However, given the pervasive uncertainty in markets we think that this represents a strategic buying opportunity on the back of our bullish call for gold to spike towards $1100 in 2009 with the potential for a much larger move over the longer term.

Given the sheer volume of liquidity that has been pumped into the global economic system over the past year it is an understatement to say the least that the price of gold has trended downward. A look at the adjusted money base of the US indicates that the money supply is up 18.6% year over year. The Fed alone has pumped over 1 trillion dollars into the economy and the US federal government will do well to avoid running a 2 trillion dollar deficit during fiscal year 2009.

The enormity of the steps taken to prevent a complete meltdown of the global banking system will put at risk years of hard won credibility of global central banks and keep the specter of inflation at the forefront of the minds of the investing class. Although, we are currently poised to observe a dis-inflationary moment as the deleveraging that is already underway has ushered in a period of intense declines in the values of assets across just about every class. With the velocity of money in decline, the contemporaneous increase in the supply of money should not stimulate an increase in inflation in the near term. However, over the longer term the independence of the central banks around the world will be severely tested by governments and publics beset by extraordinary levels of debt and increasing rates of unemployment.

Moreover, the increase in the supply of gold will fall well short of the increase in the supply of paper money over the next few years. In the context of a profound economic uncertainty, financial instability and geopolitical turbulence gold will slowly begin to reassert itself as the preferred safe haven of savvy investors, probably at the expense of the US dollar.

The risks to this scenario are two fold. First, the current dis-inflationary moment quickly unwinds and evolves into a Japanese style deflation for the US and the major economic powers, which would depress the price of commodities further and limit the upside on gold. Second, that the financial stress in the EU, Asia and emerging markets could turn out to be more pronounced than that of the US. This could cause the dollar to continue to appreciate, which would limit the upside of the move in the price of gold.

Given the volatility in the price of equities and the uncertainty in fixed income markets over the intent of the Federal Reserve at this time, we are much more confident in the direction of the price of gold over the medium term than we are that of stocks and treasuries. The steps taken by global central banks have begun to thaw credit markets and interbank lending appears to be in the process of recovering. But those, steps may be difficult to reverse and increase in dollar denominate reserves we think is a bullish signal on gold going forward.

The unwinding of positions in a panic and the intense period of deleveraging ahead has stimulated many market participants to move smartly into Yen and quite interestingly, into the dollar as a safe haven moves. Given the stability of the Japanese banking system, the move into the Yen makes sense. However, we see the recent strength of the dollar an understandably reactionary move by global investors after a half-century of a dollar hegemony, to find shelter in a global storm where no safe havens appear to exist and instead have turned to a deeply indebted US government out of habit. Thus, once the tide begins to ebb from the storm and investors can begin to evaluate the extent to which the US, EU and global governments have moved to stem the tide we do expect that gold will replace the dollar as the preferred hedge against uncertainty ahead.

By Joseph Brusuelas
Chief Economist, VP Global Strategy of the Merk Hard Currency Fund

Bridging academic rigor and communications, Joe Brusuelas provides the Merk team with significant experience in advanced research and analysis of macro-economic factors, as well as in identifying how economic trends impact investors.  As Chief Economist and Global Strategist, he is responsible for heading Merk research and analysis and communicating the Merk Perspective to the markets.

Mr. Brusuelas holds an M.A and a B.A. in Political Science from San Diego State and is a PhD candidate at the University of Southern California, Los Angeles.

Before joining Merk, Mr. Brusuelas was the chief US Economist at IDEAglobal in New York.  Before that he spent 8 years in academia as a researcher and lecturer covering themes spanning macro- and microeconomics, money, banking and financial markets.  In addition, he has worked at Citibank/Salomon Smith Barney, First Fidelity Bank and Great Western Investment Management.

© 2008 Merk Investments® LLC
The Merk Hard Currency Fund is managed by Merk Investments, an investment advisory firm that invests with discipline and long-term focus while adapting to changing environments. Axel Merk, president of Merk Investments, makes all investment decisions for the Merk Hard Currency Fund. Mr. Merk founded Merk Investments AG in Switzerland in 1994; in 2001, he relocated the business to the US where all investment advisory activities are conducted by Merk Investments LLC, a SEC-registered investment adviser.

Merk Investments has since pursued a macro-economic approach to investing, with substantial gold and hard currency exposure.

Merk Investments is making the Merk Hard Currency Fund available to retail investors to allow them to diversify their portfolios and, through the fund, invest in a basket of hard currencies.

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