Gold: Not Just for Global Disaster?

The last time an ounce of gold cost $470, Alan Greenspan was in his first year as chairman of the Federal Reserve.

Seventeen years later, Greenspan is on the verge of retiring -- and the metal finally is back to its late-1980s price level, after a long, long bear market.

The gold/Greenspan convergence is raising suspicions on Wall Street. Some believe the metal’s revival must be saying something about the economy the Fed chief is leaving to his as-yet unnamed successor.

The purchase of gold -- except in the form of jewelry or collectible coins -- often is equated with a rising level of fear among investors. If people are trading their cash for an ancient commodity, it suggests some erosion of faith in the financial system.

Is it inflation that’s worrying investors? Or deflation? Or the prospect of a global economic crash that would lead to the ruin of national currencies?

Or perhaps gold is just a beneficiary of its own recent success: The higher it goes, the more likely it is to attract hedge funds and other short-attention-span traders who are quick to jump aboard any rallying market, and who don’t care much what the trigger was.

In any case, more investors are taking note because the metal’s latest surge has lifted it $35 since late August. It’s a new phase of a gold bull market that began in 2002 after 14 years of mostly declining prices.

There was a solid explanation for gold’s 2002-04 rally: The dollar was sinking in that period against other major currencies. Because gold and the dollar are rivals as forms of money, it stands to reason that what’s bad for one is good for the other.

What’s more, because gold is priced in dollars worldwide, the weak buck made gold cheaper in other currencies. That made it more appealing to investors and jewelry buyers overseas, especially in booming economies like India.

This year the dollar has rebounded modestly against many currencies. But even as the dollar continued to strengthen in September, gold suddenly caught fire again.

Some analysts, trying to connect the dots, believe that the surge in energy prices after Hurricane Katrina may have set the scene for broad-based inflation. If that is what’s coming, it would make sense that gold -- the classic inflation hedge -- would find itself in greater demand.

Paul Kasriel, an economist at Northern Trust in Chicago, poses the question that is probably on the minds of many small-business owners and corporate executives: “How long can businesses absorb these higher energy prices before some of them go out of business or aggressively pass through some of the costs?”

Even if that pass-through happens on a wide scale, of course, almost nobody’s talking about the possibility of a return to the double-digit inflation of the late 1970s, which set the stage for gold’s record price of more than $800 an ounce in 1980.

But if U.S. consumer price inflation is 4% next year instead of the 2% to 3% that many experts foresee, it could be a shock to financial markets. That could benefit gold by default.

Some investors also might turn to the metal if they become worried about serious deflation rather than inflation.

Deflation, or a general decline in the prices of goods, services and financial assets, is what Japan lived through in the 1990s. If investors started to fear that that was possible on a global scale -- say, because of a deep worldwide recession -- gold’s historic role as a store of value could mean that it would attract money that would probably be fleeing stocks and many bonds in that sort of environment.

Indeed, any kind of economic calamity that would make people question the viability of national currencies, particularly the dollar, would most likely be great for gold, at least initially.

To go too far down that road, however, is to enter the realm of the survivalists and others who believe the end of the world as we know it is imminent. If that day were to come, let’s face it, you’d probably be smarter to own shotguns than gold bullion.

Jim Melcher, president of money management firm Balestra Capital in New York, owns gold and is no fan of U.S. markets. But he also says he isn’t planning for Armageddon.

Melcher views gold in the same light as foreign currencies and foreign stocks: a way to diversify against the risk that the U.S. is overstretched financially because of its massive trade and budget deficits and will increasingly struggle to compete with the rest of the world.

“This is no longer a country in a growth phase,” he says. “You’ve got to invest where there’s growth.”

That’s harsh, and many trillions of dollars of investment in the U.S. say Melcher’s wrong.

Even so, consider what the average U.S. mutual fund investor has been doing: Americans invested nearly twice as much in foreign stock funds in the first half of this year as in domestic stock funds, according to the Investment Company Institute.

Undoubtedly, part of this new love affair with foreign shares reflects the terrific run that overseas markets have had over the last three years, boosted by the falling dollar. People are chasing that performance. Yet even as the rebounding dollar has damped foreign returns this year, U.S. fund investors have continued to send money overseas.

Some of those investors may be as concerned as Melcher is about America’s future. Most, however, would probably say they’re just trying to be prudently diversified.

Gold may now find itself a beneficiary of that same mind-set. There may be an undercurrent of fear in investors’ gold purchases, but it may be less a fear of catastrophe than a recognition that the global economic and market landscapes are changing, and the outcome is uncertain.

The metal was a terrible investment in the 1990s as inflation dwindled and financial assets roared. Now, there are enough questions about inflation and the outlook for financial assets to at least make gold a contender as investors think about how to divide their portfolio pie.

The challenge gold poses for individual investors is how best to own it. Gold coins, like the American Eagles issued by the federal government, are easy enough to buy, but then there’s the issue of storing them safely.

Many investors have opted to own gold via mining stocks, such as Newmont Mining Corp. or Barrick Gold Corp., or gold-focused mutual funds offered by many fund firms including Vanguard Group and Fidelity Investments. The stocks, and the funds, tend to act like gold on steroids: They often rally more than the metal itself when the price is rising and decline more sharply when the price is falling.

This year, for example, the price of gold bullion is up 7.2%, as measured by futures contracts traded in New York. But the average mutual fund holding precious-metal stocks is up 14.8%, according to fund tracker Morningstar Inc.

Another option: a New York Stock Exchange-traded fund called the StreetTracks Gold Trust (ticker symbol: GLD), which is designed to track the performance of bullion.

For more ideas, the World Gold Council website is interesting reading, at www.gold.org -- as long as you keep in mind that it’s there to promote the metal.

Tom Petruno can be reached at tom.petruno@latimes.com.