Gold: Riding the Crest of a Perfect Storm With Risk Heavily Skewed to the Downside

 |  Includes: GLD, UDN
by: Calafia Beach Pundit

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In inflation-adjusted terms, gold prices in the past century have been higher than they are today for less than two months, from mid-January 1980 through early March 1980. The peak nominal price of gold ($850/oz.) occurred on January 21, 1980, and would correspond to about $2,450 in today's dollars, according to my calculations using the CPI. If history repeats itself, gold could gain another 35% or so briefly, after already rising over 700% in the past 10 years, before becoming one of the worst investments in the world for the next decade or two.

Gold is riding the crest of a perfect storm these days. Geopolitical turmoil is all around us, with even the staid streets of the U.K. beset by mindless violence. Several of Europe's most venerable countries are teetering on the brink of default. Almost every major central bank in the world is trying hard to get inflation to move higher. In inflation-adjusted and trade-weighted terms, the dollar is at an all-time low against a large basket of currencies. The Fed has just announced that it will keep short-term rates unusually low for at least the next two years, thus inviting rampant speculation and leveraging. Gold is the traditional safe haven for political and monetary risk, and there is plenty of both to go around.

Indeed, it's hard to imagine conditions being more favorable for gold. Except for one thing, which is that it is becoming quite expensive relative to other goods and services. It has only rarely been more expensive to buy gold. Some say it could go to $2500 or even $5000 per ounce, but no one really knows. As a value investor, I look at the potential upside (35%) versus the potential downside (-80%?) and I shy away. The risks are very disproportionately skewed to the downside.

What could trigger a gold collapse, and could it happen soon? I doubt that any gold-killing development is going to surprise us soon, but when it does (and it inevitably will happen), it could be the news that inflation is making an obvious comeback. That would be enough to get central banks to reverse course by raising interest rates.