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Bubble Trouble? Here's a Golden Alternative

Apr. 26, 2011 10:33 AM ET
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Jim Trippon's Blog
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It's hard to keep track of the dueling opinions this month. One day we find the media filled with stories about the endless growth potential of gold. The next day there are dire warnings that gold has entered bubble territory and a sharp correction is due sometime soon.

Who is right?

One thing we can be sure of is that the U.S. dollar continues to weaken. Last week's warning about the quality of U.S. debt from Standard and Poor's underlined a stark fact that most investors already know: the U.S. debt crisis is eroding confidence in the country and the greenback.

It is no coincidence that gold broke above the crucial $1,500 an ounce limit shortly after S&P issued its warning. Nervousness about Washington's ability to manage its fiscal problems has been ramping up since last year. The S&P warning merely put an official stamp on investor fears.

As gold broke through its latest ceiling, we received reports from all over the globe predicting even more new highs. GFMS Ltd., a London-based metals consultancy, told the Wall Street Journal that gold will reach $1,600 an ounce before the end of this year.

An even more optimistic outlook on the future of gold comes from Reuters which reports that a poll of analysts predicts that gold will hit a high of $1,700 by year's end.

Looking further into the future, a Standard Chartered bank report says the price of gold could reach $2100 per ounce by 2014.

Astonishingly, the bank says the price of gold may shoot up as high as $5000 per ounce by the end of the decade. The Standard Chartered report also says gold prices have not yet hit a predicted super cycle. That will come later in the decade when demand from emerging economies like China and India hits a peak.

Is It A Bubble?

Trouble is, there are almost as many gold bears as bugs in the current environment.

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Millions of investors do see gold as a haven from a host of troubles, troubles including the dollar, inflation, Europe's debt crisis, shocks in the Middle East and Japan's ongoing earthquake-related fallout.

The danger is that today's gold rush could easily turn into a stampede for the exits, driving the value down dramatically. The world's sense of risk shot up in recent months with events in the Middle East, Japan and Europe, and gold's value rose right alongside. But if global risk perception abruptly improves, there might suddenly be a lot more gold sellers than buyers.

Could the gold bubble burst? Currently I see few indications that the sense of risk currently feeding the gold market will diminish. Middle East instability is only increasing. Europe's debt woes appear to be headed for a new crisis. Japan's business climate seems unlikely to return to anything like normal before the end of the year.

And, of course, the U.S. is certain to amplify the world's anxiety about the dollar as politicians engage in a game of chicken over the debt ceiling. Keep in mind that failing to raise the ceiling in time would effectively create a default on the dollar, resulting in a new global economic crisis.

What about the new kid on the block – the economic powerhouse with trillions in reserves? China holds approximately $1 trillion in U.S. debt instruments and it seems that Beijing is having serious second thoughts about the full faith and credit of the U.S. government. China is also wondering aloud about the wisdom of holding such a vast hoard of reserves whatever currency they may be denominated in.

China's version of Ben Bernanke and Tim Geithner rolled into one, central bank Governor Zhou Xiaochuan, has signaled a major change in the fiscal climate. After accumulating the largest stockpile of foreign reserves ever seen, Governor Zhou said: enough! "Foreign-exchange reserves have exceeded the reasonable levels that we actually need," he said.

Zhou added a veiled warning that buying more dollars and deutschmarks in China's reserves could contribute to the nation's severe inflation problem.

If Not Gold or Dollars, What Next?

Most indicators seem to point to an ongoing rise in the value of gold and other precious metals in the near term. But no experienced investor puts all of his eggs in one basket – especially when there is a risk that gold prices will face a setback.

Traditionally, investors have been advised to "go to cash" in times of crisis. But going to cash means selling stock and accumulating dollars. And, with the dollar in a protracted decline, the U.S. greenback has become just another speculative tool, right along with stocks, precious metals, and other currencies.

Which one is today's safe haven? Probably the safest thing to do is to spread the risk.

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Among currencies, the Chinese yuan is showing potential for continued gains. The value of the yuan is closely tied to the U.S. dollar but so far this year, Beijing has allowed the value of the yuan to rise by about 4.5 percent. Will the trend continue?

I believe that it will. China's key challenge is managing domestic inflation. Much of that inflationary pressure comes from importing commodities like oil and copper which are denominated in dollars. Raising the value of the yuan would provide quick relief.

Once again, China's godfather of finance has weighed in. Zhou Xiaochuan says that China is using the yuan as a tool in fighting inflation. Zhou also says he will make the currency more flexible over time.

China's Premier has also echoed Zhou's hint about a rising yuan. Premier Wen Jiabao says Beijing will, "further improve the yuan exchange rate mechanism and increase yuan exchange rate flexibility to eliminate inflationary monetary conditions". In short, the yuan will rise to fight inflation.

I have advised my subscribers at the China Stock Digest to place the cash portion of their China-focused accounts in ETFs which track the value of the yuan.

There are no guarantees about the future value of the yuan. China has signaled a rise in the currency for good reasons, but Beijing faces pressures from exporters who would be hurt by a rise in the currency. It will be a delicate balancing act.

Investors should also engage in some delicate balancing to diversify their portfolios for safety. Gold may not be the only choice as a safe haven. The yuan is a new rising star. I believe it is on its way to becoming a new global reserve currency.

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Global Profits Alert (GPA) is published by Trippon Financial Research, Inc. a financial media organization with offices in the United States, Hong Kong and Mainland China. GPA is written by Jim Trippon in conjunction with George Wolff, Sunny Wang, Todd Shriber, Kelley Damiani and J. Daryl Thompson.

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