2 Reasons Why Gold Could Rally

| About: SPDR Gold (GLD)

Over the course of this year, a rather odd thing has happened: gold (SPDR Gold Trust ETF: GLD) has traded more in line with risk assets than safe haven securities. This is a notable break from recent crisis-time precedent, as conventional wisdom says "buy gold during uncertain times". Gold hit a low of $1,527 an ounce on May 16, down around 20% from its all-time high of $1,920 per ounce last September in the wake of the United States downgrade. The move down and the YTD performance of the metal underscore a fundamental disagreement as to how gold should be classified: is it simply a commodity to be traded like oil, or is it a store of value that serves as a perpetual hedge on inflation.

Two factors—one less publicized and far more interesting than the other—may suggest the yellow metal is primed for another run at $2,000 per ounce and beyond. First, the possibility of further easing by the Fed has served as fodder for gold bulls for some time now, though the Fed's decision to extend Operation Twist and (for the time being) forego further balance sheet expansion triggered a rather sharp sell-off on June 21. Despite this, the Fed did leave the door open for more easing:

"The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability"

Given this, there are still many who believe the Fed will buy assets sooner rather than later as the United States economic recovery continues to stumble.

The second reason to believe a rally in gold could be on the horizon comes from a relatively obscure memo circulated by the Office of the Comptroller of the Currency and the FDIC. The memo proposes changes to the agencies' capital rules. One such proposition is particularly interesting:

"(3)
Assets not included in a defined exposure category. (i) A [BANK] may assign a risk-weighted asset amount of zero to cash owned and held in all offices of the [BANK] or in transit and for gold bullion held in the [BANK]'s own vaults, or held in another [BANK]'s vaults on an allocated basis, to the extent the gold bullion assets are offset by gold bullion liabilities."

This means that should the rule take effect, overextended banks will no longer have to set aside precious capital against their holdings of gold. What is perhaps most important about the proposed move is that it would remove the unfair advantage until now enjoyed by government bonds as explained by John Butler, co-founder of Atom Capital in London:

"...it will be an important step toward the re-monetisation of gold. Gold would be able to compete on a level playing field with government bonds. While the playing field could be leveled in this way, there would be a gross mismatch on the pitch. On the one hand, you have unbacked government bonds, issued by overindebted governments, yielding less than zero in inflation-adjusted terms. On the other, you have gold, the historical preserver of purchasing power par excellence."

In other words, this couldn't come at a better time for gold. The metal has sold-off from its highs and is thus ripe for a rally at the same time as investors becoming increasingly disillusioned with other so-called 'risk free' assets such as debt issued by governments whose debt-to-GDP ratios exceed 100%. Throw in the possibility of a new round of quantitative easing, and you have a perfect recipe for a rally in gold. My advice: Long GLD.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.