by Tom Taulli | April 5, 2012 11:56 am
Wednesday was an ugly day for gold, which plunged 3.5% to $1,612.30 based on the April futures contract. The precious metal is at its lowest point in 12 weeks.
Why the drop? Investors are concerned that the Federal Reserve will not launch another round of quantitative easing (QE3). This program involves large purchases of bonds in hopes of stimulating the economy. It also could lead to higher inflation, which usually is a positive catalyst for the price of gold.
Still, plenty of analysts think gold still can head past its 2011 highs by the end of this year. So should you be bearish, or is now the time to buy? Here’s a look at the pros and cons of buying gold:
Safe Haven: Since the financial crisis of 2008, governments across the world have been aggressive with their fiscal and monetary policies. While inflation has been moderate in the U.S. and Europe, this has not been the case in many emerging markets. The result has been a boost in demand for gold as a hedge. As the saying goes: A government can’t print gold.
Peak Gold: In a free market, a higher price should lead to increased production. But this has not been the case with gold. The main reason: It is getting more difficult to find new deposits. Because of this, gold miners like Barrick Gold (NYSE:ABX), Newmont Mining (NYSE:NEM) and Goldcorp (NYSE:GG) have had challenges increasing their reserves.
Thus, with limited supply, the price of gold is likely to remain strong even if demand does not increase significantly.
Emerging Markets: As these countries continue to grow, they might be less willing to hold U.S. dollars. After all, what if there is a prolonged bear market in the currency? As a result, gold should be an attractive store of value.
This especially is the case because, as mentioned before, inflation remains a problem in emerging markets — especially in China. The country has been loosening regulations on the ownership of gold, and in fact, most large Chinese banks now offer gold-denominated savings accounts.
Low U.S. Inflation: During the past month, gold saw two big drops (and silver was held back, too) because of the Fed’s signaling that it will refrain from loose monetary policy. This might mean that investors had been factoring in an eventually higher inflation rate — and the expectation might have to be readjusted if the Fed is pursing tighter monetary policy.
Passive Asset: Gold really has few applications, except for jewelry and some industrial processes. It also has no productive value, such as with generating profits and dividends. According to Berkshire Hathaway‘s (NYSE:BRK.A, BRK.B) Warren Buffett: “If you own one ounce of gold for an eternity, you will still own one ounce at its end.” Instead, he’d rather own top-notch companies like P&G (NYSE:PG), Coca-Cola (NYSE:KO) and IBM (NYSE:IBM). And who can blame him?
Bear Markets: When gold gets down, it gets down — bear markets for gold can be long-term and brutal, versus stocks and bonds, which might see sharp drops but seem to snap back faster. Keep in mind that from the early 1980s to the late 1990s, gold essentially treaded water.
If anything, the long-term drivers for gold still look promising, such as with the limited supply, its role as a safe haven and the growing demand in emerging markets. In light of all these, pros outweigh the cons for this asset.
One great way to get exposure is through an exchange-traded fund like SPDR Gold Shares (NYSE:GLD) and iShares Gold Trust (NYSE:IAU). These vehicles have vaults with gold bullion, and their stock prices fairly accurately track the movements in the spot price of gold.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.
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