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With gold in the mid-$1300s ($1356.70 as of February 11 close), still within sight of its historic nominal high of $1421 on November 9, 2010 [i], people who have accumulated gold and gold-related assets are asking if it’s time to sell. While it’s never wrong to manage risk by trimming assets when prices appreciate, I believe that there is a good case for U.S. investors who have diversified into gold investments to hold those assets now:

  • The highest demand for gold is in India [ii], where for much of the population holds physical gold instead of keeping savings in banks, and Indian gold demand sags in the first quarter, after the traditional end-of-year wedding season ends [iii]. That being the case, the fact that gold has lost less than 5% of its value from its 2010 all-time high shows underlying strength.
  • While gold critics may belittle allegiance to a physical metal whose value derives largely from psychological perceptions of value rather than industrial use, concerns abound for all existing international currency standards:
    • Concerns about the size of the U.S. government’s deficit threaten to challenge the United States’ triple-A credit rating over the long term, generating risks for the dollar.[iv]
    • National debts in Europe continue to generate concerns about the euro, heightened by recent uncertainty over who will succeed Jean-Claude Trichet as Chief of the European Central Bank [v].
    • The Chinese yuan (or renminbi) continues to be subject to various controls, so that it’s not yet viable as a broad reserve currency, and extensive Chinese government dollar holdings that would diminish in value if the dollar drops precipitously guarantee that yuan control reductions will move at glacial speed.
  • While hopes are high that a U.S. economic recovery is fully on track, there is risk that it will not be self-sustaining by the end of 2011, when this year’s 2% payroll tax cut is currently scheduled to expire.

Timing of U.S.-related factors and the Indian wedding season

A particular note about the U.S.–related factors: they will become more influential as the year progresses. The U.S. faces an extensive political debate about debt reduction this year that begins in earnest with President’s Obama’s rollout of his fiscal year 2012 budget request to Congress this week. All agree that government spending must be trimmed, but negotiating real reductions will be challenging. If the U.S. can’t meaningfully cut the federal budget, the failure will become more apparent in the third quarter, as politicians scramble to make a deal before the federal government’s fiscal year begins on October 1, just when the Indian wedding season demand for gold is ramping up.

Conclusion

Unless the U.S. experiences a recovery so strong that increased government tax revenue will ease deficit concerns or U.S. political leaders make a genuine deficit-reduction breakthrough, there is a logical thesis for gold and gold-related assets to appreciate in the second half of 2011 that is compounded by seasonal Indian factors.


[i] See The London Bullion Market Association, here. Gold’s inflation-adjusted high has been calculated to be $2318.84. See Cladia Assis, Marketwatch, Sept. 24, 2010, here.

[ii] See ETF Daily News, “Gold: Investment Demand In Flux (NYSEARCA:GLD),” Feb. 1, 2011, here.

[iii] See Thoughts Worth Thinking, Seeking Alpha, “Use Caution Investing in Gold This Quarter,” Nov. 20, 2009, here.

[iv] See Thoughtsworththinking.net, “U.S. Triple-A Sovereign Credit Rating is at Risk of Downgrade”, Dec. 27, 2010, here.

[v] See Dave Kansas, WSJ Blogs MarketBeat, “Good for Gold? Weber, ECB Hawk, May Depart,” Feb. 9, 2011, here.

Disclosure: I am long ABX and do not hold positions in SPDR Gold Trust (GLD), iShares COMEX Gold Trust (NYSEARCA:IAU), or a position in gold bullion.

Source: Why It's Good to Hold Gold in 2011