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Gold: Bull’s and Bear’s Best Friend

There may be a pot of gold bars and precious metal at the end of the rainbow after all – regardless of which direction the global economy heads from here on. Mining commodities such as copper, nickel, aluminum, and particularly gold, have traditionally been regarded as a hedge against inflation and bearish economic times. So it makes sense that gold has recently hit an all-time high and is seemingly on a continued ramp-up. However, I believe that gold and mining will flourish regardless of economic collapse or boom.
First, the bear scenario
History has already proven that gold thrives as an investment in bearish economic times. I don’t need to convince you that this is the case in the current global economy as well. Just for completeness – back to econ101, gold assumes its natural role as a store of value when purchasing power is threatened in the economy. This is the current situation in the United States, and as the dollar continues to decline in value, gold will become more precious globally. People and firms respond by fleeing to safety during times of uncertainty like this.
A recent study performed by IBISWorld (April 27, 2009) on the mining industry supports this hypothesis that gold will significantly rise “due to investors seeing it as a reliable defensive investment”. Despite the fact that 89% of all gold mined is used in jewelery, of which sales are expected to decline with the recession, price increases will be driven by investments. Higher prices of gold and silver have also lead to increased industry revenues by 16% in 2008, and expected to be higher for fiscal 2009.
Overall, as long as investors remain nervous about the economy, government debt / deficits / artificial stimulation, or inflation, gold will continue to be seen as a safe haven and prices would be pushed higher. It’s hard to estimate a ceiling, but doom-advocate Peter Schiff calls gold at $5,000. That may be a little extreme, but is just one of the views on gold’s potential.
Then, the bull scenario
Another consideration is that a steep recession would be followed by a sharp economic recovery, spurted by central bank interest rate cuts and government stimulus. If the government lives up to its recent promises, interest rates will stabilize one year out to prevent excess inflationary pressures. Unemployment will decrease, spending and capital investments will increase and somehow (perhaps magically) government debt will slowly start to stabilize.
However, an important point to keep in mind is the massive loss of reputation and belief in the government’s ability to stabilize the economy that has occurred in the last year; in effect, this will lead investors to be vigilant during the ride up for matters like inflation. Regardless of an economic bullish scenario, investors will continue to use gold as a hedging tool against possible inflationary forces caused by government stimulus (or keeping interest rates too low for too long). Also, in this scenario, physical demand will be spurted in the jewelry (89%), dentistry (7%) and industrial (4%) gold market segments leading to price appreciation.

Just for interest’s sake, other precious metals may also follow gold’s path in the bullish scenario. Based on a recent Societe Generale industry report (October 13, 2009), other precious metals such as copper, aluminum, nickel and lead will benefit from bullish forces. Copper and lead/zinc will benefit from limited supply as industrial consumption increases in China and elsewhere. Lead and zinc will be further boosted by a strong recovery in the steel industry and auto production. Current aluminum build-ups will begin to reverse as well.
However, a third potential scenario is a moderately slow return to economic growth. In this situation, the US stimulus plan would take some time to take effect and the rest of the globe would assume a slow recovery as well. In this case, interest rates would slowly rise as promised by the government and unemployment levels would be extended by semi-weak consumer spending and low growth of business.
The implications of this scenario on gold and precious metals are not as optimistic as in a strictly bear or bull scenario. As market confidence slowly improves, gold may no longer be used as a risk hedge and therefore prices may cease to increase. Furthermore, if the central bank acts as promised and begins to increase interest rates, reduced worries of inflation may also drive the demand of gold lower. Any increases in physical demand of gold would take too long to kick in and the reduced investment in gold would drive the price down prior to increased physical demand.
Gold’s breakout and achievement of an all-time high was a significant event.  The potential for gold as an investment is significantly more attractive in the bearish scenario for the next two to four years since fears of economic collapse would weigh much more heavily on gold investors than any of the other factors mentioned above; nevertheless, even if the global economy begins to pick up pace, gold and other relevant metals will still benefit and appreciate in the short and medium term. As mentioned, if neither a bullish or bearish scenario occurs, gold could potentially be exchanged for more lucrative investment opportunities.

What do you think will happened in the next four years?

Disclosure: long gold.