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Gold Isn't Safe Either

|Includes: DJP-OLD, SPDR Gold Trust ETF (GLD), IAU

Gold may not be such a safe haven after all.

Momentum has cooled since gold prices reached a nominal record high around $1,260 a troy ounce just weeks ago. Don't be surprised if that level is not revisited.

Gold prices have gone berserk in the second quarter of 2010, more so than in any other period during the past two years. Recently, gold has also fallen out of sync with the DJ-UBS Commodity Index (see below), indicating that the market is not properly valuing commodities. This could be cause for concern. Furthermore, manufacturing demand for gold has shrunk drastically, due in large to declining jewelry sales. Investors last year bought more gold than buyers of jewelry for the first time in three decades, the Financial Times recently reported. Such alarming data should be reason enough to steer clear of precious metals.

Gold/commodity spot comparison

Despite these risks, investors are still flocking to gold for a number of reasons. Everywhere we go, we are bombarded with advertisements telling us why we should dabble in gold. (Heck, even Mr. T wants your gold!) Pundits continue to urge us to buy gold as protection from inflation and as a hedge against currency devaluation. I even witnessed one "expert" suggest that gold was a good hedge against deflation. Then there's that outrageous apocalyptic view that the world economy will collapse, and whomever holds the most gold at the time will prosper. According to these views, it seems one could do no wrong in ever buying gold! This belief continues to fuel the virtuous cycle that is propelling high gold levels. The culmination of these factors presents the illusion of a sound investment.

Wall Street loves this scenario, as it does all bubbles, riding them out for all they're worth. As with any asset bubble, investment bankers trade on the back of widespread belief and consequently drive up market prices, even when underlying fundamentals are less than attractive. Increased liquidity in the market, vis-à-vis exchange-traded funds, makes it easier than ever for bubbles to form and be played.

Proponents are quick to remind everyone that gold is still a long way from its record inflation-adjusted high above $2,300 an ounce in 1980. To put things in perspective, the hot-button issue back then was hyperinflation, which drove the price of commodities through the roof. Baby boomers were reaching their prime spending years. The federal funds rate at the time was over 10 percent, compared to almost zero percent today. Nevertheless, many investors are increasingly concerned about inflation. This time, the worry is that the central bank's massive monetary expansion (a.k.a. stimulus) will yield nasty inflation. Consumer price index data however suggests that inflation is nowhere in sight. With interest rates so low, any unwanted inflation that does result can easily be suppressed by way of raising the federal funds rate. Therefore, buying gold to protect against inflation doesn't seem to jive either.

Savvy investors know that no investment is infallible, and that nothing can go up indefinitely. There's no such thing as a "safe investment". At $1,200 an ounce, gold still trades at a dangerous level. In fact, some Wallstreeters have already began moving away from gold. "Smart money" interests, including George Soros, Jeremy Grantham (NYSEMKT:GMO) and those at Goldman Sachs, began reducing their gold ETF positions in the first quarter of 2010.

The high price of gold is buoyed by artificial life support by way of synthetic instruments and irrational fears. Ultimately, though, its current level is unsustainable. It's only a matter of time before the gold bubble bursts, dragging other commodities down with it. 

Disclosure: No positions