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The Gold Play: Hedging against fallacy

|Includes: DGZ, SPDR Gold Trust ETF (GLD)
Over the past year it seems investors have been split between whether inflation or deflation will take hold of the U.S. economy in the years to come. More recently, though, in the face of the Greek crisis, the sentiment has swayed increasingly toward inflationary concerns with investors acutely aware of the risks behind excessive quantitative easing in both the U.S. and Europe. The “gold play”, typically utilized as a hedge against inflation as well as a hit on currencies, has driven gold to record highs over the past few weeks. There haven’t been signs of a sell-off yet, either. Institutional investors have only increased their positions in gold according to the U.S. Commodity Futures Trading Commission.
Should investors really be concerned with inflationary pressures?
U.S. Concerns
In the U.S., economic indicators are suggesting quite the opposite. The Consumer Price Index (NYSEARCA:CPI) excluding food and energy only increased 0.9% from a year earlier and was unchanged over the past two months. This is in comparison to increases of 2.3%, 2.3%, and 1.9% for the 12 months ended April 2007, 2008, and 2009.  With such low growth in prices in relation to previous years (especially after the amount of stimulus that the government has injected into the U.S. economy over the past year and a half) deflation should, perhaps, be of greater concern.
Additionally, unemployment increased from 9.7% to 9.9% over the first quarter of this year. It would be counterintuitive to assert that businesses would increase prices with a rising unemployment rate, which again implies very little inflation if not deflation. This idea prevailed in the Federal Reserve’s recent Beige Book noting that while producers’ costs swelled, they were unable to pass them onto selling prices.
Building permits, a figure considered more stable than housing starts, while having increased over the trailing 12 months by 15.9%, declined by 11.5% since March signaling cautious growth in the economy.
Federal Reserve’s long-run inflation projections were between 1.7 and 2.0 in both 2009 and 2010 with lower projections for the nearest-coming years. So, while the idea that trillions of dollars were pumped into the U.S. economy would normally be cause for worry over inflation and thus greater investment in gold, in this case it would appear there is no basis for it.
Now, though, price pressure on gold seems to be only partially related to the dollar, with a majority of speculation arising from concern over the euro.  
European Concerns
With unease over Greece spreading to other countries like Spain and Portugal there is certainly reason to take protective measures; however, it appears that there has been an overly dramatic rise in the price of gold as a result (23% over the past 3 months). While Europe has just embarked on a quantitative easing program, the economic state of the region can hardly be considered a hotbed for inflation, and certainly not a candidate for further serious currency devaluation. As such, the question that remains is why gold has been bid up to around 5 times its price in 2000? The answer is likely that investors are hedging against a fallacy. Thus, a reasonable correction is likely to transpire over the next couple of weeks.

Disclosure: No Positions