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A gold-plated inflation scare
The metal's recent jump and high oil prices have some seeing serious inflationary pressures ahead.
June 29, 2005: 3:03 PM EDT
By Katie Benner, CNN/Money staff writer
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NEW YORK (CNN/Money) - Gold rising along with the dollar -- and with oil jumping to record highs near $60 a barrel -- may signal a pickup in inflation ahead.

It's enough to give a gold bull deja vu.

A handful of precious metals insiders at the recent New York Institutional Gold Conference predicted that the price of spot gold will hit $850 an ounce in the next few years from its current level near $440.

The last time it got anywhere near that high was in the late 1970s when out-of-control inflation, unrest in the Middle East and an oil crisis pushed the precious metal from $150 to $810 a troy ounce.

Gold is currently trading 30 percent above its 10-year moving average on the New York Commodities Exchange, and gained five percent this month to stand less than $10 away from March's peak at $446.70, even while the greenback gained against the euro.

During the recent dollar rally, the American Stock Exchange's index of gold-mining stocks, or BUGS, also moved toward three-month highs, and individual gold and mining stocks including Placer Dome (up $0.50 to $15.66, Research), Newmont Mining (up $1.18 to $39.80, Research) and Barrick Gold (up $0.93 to $25.63, Research) have moved in tandem with indexes.

This, some economists contend, points to a troubling inflation problem, greater than currently perceived.

"Despite all the rate hikes, the (Federal Reserve's) overnight lending rate is still less than inflation," said James Turk, co-author of the book The Coming Collapse of the Dollar and How to Profit From It.

Black gold

It is oil prices that are really making the gold market look like 1970s redux, with crude prices hovering near $60 a barrel.

While economists debate whether high oil prices will spark inflation or slow economic growth by acting as a tax on consumers and businesses, the gold market has come down on the side of inflation.

Bond investors also showed some nervousness about inflation last spring, when the 10-year Treasury yield jumped to about 4.6 percent in early April as crude prices spiked. But yields have since backed off.

"The recent run in gold has moved in conjunction with rising crude prices," David Meger, senior metals analyst at Alaron Trading, said in a recent note.

And gold prices also began to jump higher in the third quarter of last year, concurrent with an oil price surge.

"Middle East nations are getting more petro-dollars as (oil) prices rise, and they're not putting it back into paper assets," said Charles de Vaulx, manager of the First Eagle Gold Fund. "They're trying to protect the value of their profits -- just like in the 1970s -- so they're buying gold," he said.

With oil prices so high, some traders believe there's still a considerable upside to gold, despite the fact that some market analysts, like MKM Partners' chief market technician Katie Townshend, say the metal has become overbought in the short term.

"Based on historic ratios between gold and oil, gold should now be over $500 an ounce," said Frank Holmes, chairman and chief investment officer as U.S. Global Funds. "Or the price of oil needs to come down to $40 to $42 a barrel." (Will oil prices hit $100? Click here.)

Forget a stronger dollar

When inflation grips a market, the value of dollar-denominated assets is eroded. So a shift to gold represents, among other things, a broader shunning of financial assets in favor of hard assets as a hedge against perceived currency risks.

"Even Warren Buffett is buying gold because he sees the dollar as weak," claimed Turk.

At the moment, however, gold and the dollar are both rising. But metals traders argue that the price of gold is still an accurate indicator of inflation risks, because the dollar's rise doesn't reflect true strength, only relative value compared to an equally troubled currency.

"Confidence in the euro as an alternative to the dollar has fallen apart," said Frank Holmes, chairman and chief investment officer as U.S. Global Funds.

Michael Darda, chief economist at MKM Partners, said that currency weakness across the board has helped to keep the dollar from falling as gold rises.

"Gold prices are rising against almost every major currency," said Darda, noting that it's unusual for gold and the dollar to be rising at the same time. "So the run up in gold prices here has not affected the dollar to the benefit of other currencies."

Darda said spot gold would have to hit over $1,000 an ounce to signal a currency market collapse like the one that hit at the end of the 1970s.

Few analysts believe the metal will trade between $600 and $800 over the next few years, mostly because they assume rising oil prices will slow demand for fuel and eventually bring crude prices down.

But consulting firms like Alaron Trading are still bullish on gold, particularly because they see weakness in a variety of paper assets.

"Four to five years ago when the equity bubble burst we were hopeful that gold demand would surface. But people went to other asset classes like real estate or hedge funds," said de Vaulx.

"We're seeing both real estate and hedge fund become more uncertain now, and if it's going to happen, we'll see the investment demand for gold," de Vaulx said.

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What's the Fed saying about inflation? Click here.

Will we see $100 a barrel crude? Click here.

What about a real estate bubble? Click here.  Top of page

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