Trading at 25% down from an all-time high of $1,921 per ounce, gold's recent prices may have you thinking that the bull run is over.
Does it still have a place in your portfolio?
True, the world economic financial crisis is mostly behind us; the dollar is strengthening; and the U.S. stock market has recovered to new highs. In other ways, the recovery is gaining momentum. Because gold prices tend to move opposite of currency-based investments like equities, bonds, and cash, changes in the dollar and economic improvement have caused some to reduce positions in gold or to avoid adding gold to their portfolio.
But confounding many investors and observers, while gold prices have had a major correction, demand for physical gold has skyrocketed, causing dealer shortages. There are several reasons:
* Post financial crisis the global economy still faces significant problems-ones that defy easy fixes and that won't be addressed anytime soon. Significant challenges include the EU's shrinking GDP and the severe debt load of some members, most notably Greece.
* Our fragile, gradual improvement still looks like gangbuster growth when compared to Europe. As a result, the dollar strengthened when compared to the Euro and other currencies.
* Further, gold demand has increased from central bank buying sprees and the new middle class in India and China are using gold as a storehouse of wealth.
* The recent correction was caused mainly by a selloff by momentum investors dumping paper gold investment vehicles like exchange-traded funds, futures, and shorts. That disguised the fact that physical gold demand remained strong among conviction investors, who now view these lower gold prices as a buying opportunity.
When I was director of the United States Mint, I oversaw a 500% increase in gold and silver bullion production during the period from 2008-2011. A significant production increase continues to this day with silver bullion demand setting a record in January with gold not that far behind.
More importantly, gold prices have correlated best with the federal debt limit and how close our deficit comes to reaching it. Since the financial crisis in 2008, gold prices have risen in lock step with each time our federal debt ceiling has been raised and our deficit spending hits that ceiling.
With our nation's fiscal policy in shambles, the federal debt ceiling will need to be raised to accommodate huge budget deficits for years to come. Therefore, expect gold prices to rise accordingly.
But while gold will likely rise; it will do so with increased volatility. The seemingly endless swings between austerity and business-as-usual in the EU, the inability of Congress and the White House to even trim the rate of increase of our spending, and the lack of transparency with China's economy have caused greater uncertainty with investors. In turn, this has led to greater volatility with every tidbit of news causing bigger swings.
What does an investor do with gold in this environment? Diversify in the short term and invest for the long term.
Diversification into gold is a good strategy in a time of increased uncertainty. Owning physical gold is an insurance policy against a downturn in the dollar. But it is also a tangible asset, which is becoming increasingly important in this age of cyber attacks on our banking systems. Physical gold has intrinsic value and what you possess won't disappear if the computers go down.
Investing in gold for the long term avoids the unpredictable volatility swings in the price of gold. The long-term fundamentals continue to be very strong for gold. Under any scenario, our debt ceiling and our deficits will continue to go up. Our economy (and Europe's) is not expected to have a robust recovery anytime soon. The magnitude of the Fed's QE reduces its options to unwind.
The fastest growing way to invest in gold for the long term is through a precious metal IRA.
Authorized by Congress in 1997, they are picking up steam among investors over the past few years. For most, this is rolling over a portion of their existing IRA to a self-directed IRA. The industry has now made the transaction seamless to the investor by pulling together all the pieces into a one-stop shop: the purchase of qualified bullion coins, the self-directed IRA administrator, the IRS-approved depository, and the physical transfer of precious metal bullion. That's what attracted me to set up my gold IRA in 2011. Sales have jumped accordingly.
Is there a scenario where gold positions should be greatly reduced? Yes. I would begin to reduce my gold position if we got our fiscal house in order and start running budget surpluses that negate the need to increase our federal debt ceiling. Another catalyst would be if the EU got a permanent solution to its member countries' debt problems. Because hope is not a good investment strategy, I am currently increasing my gold allocation.
Edmund Moy is the chief strategist for Morgan Gold, a provider of gold IRAs located in Irvine, Calif. He was Director of the United States Mint from 2006-2011.