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What Investors Should Know About Gold Rally

Tuesday, 11 May 2010 | 6:02 PM ET

Gold settles at a record high price on the COMEX and everyone wants to know, will it go higher?

Many traders think the answer is "yes."

Gold coins and bar
Gazimal | Iconica | Getty Images
Gold coins and bar

In the short-term, the gold rally is, “directly attributable to the euro decline and instability that we have seen this week”, says Adam De Chiara, Jefferies Asset Management Co-President. “Gold is serving as a currency alternative for many investors—a place to hold their wealth.”

Traders on the NYMEX trading floor are also mostly bullish on gold, for the most part.

Why? Several factors. The European Union’s extraordinary measures are seen as simply “buying time” before other sovereign debt issues arise. The EU’s massive bailout is going to lead to inflation, which tends to prompt gold investing.

Then, there are the technical factors—higher highs, higher open interest, higher volumes often lead to the continuation of a bull run.

Taking the longer-term view, some say market fundamentals also point to higher prices. According to Frank Holmes, U.S. Global Investors Chief Investment Officer, gold still has a long way to go just to reach its inflation-adjusted high of $850 per ounce first reached back in 1980. “$2300 in the next five years is a reasonable forecast,” he says. And, it “…could happen faster if something silly happens.”

The two biggest factors in higher gold prices, Holmes says, are interest rates and deficit spending. "When interest rates are negative to inflation, what you are earning on your money in money markets is negative.” This makes it cheaper to hold gold. Add in high deficit spending, and, Holmes says, watch for the price of gold in that county’s currency to climb—hence record high gold priced in U.S. dollars.

“India looks smart,” he says “they bought IMF gold in October 2009”. Russia was also a buyer he added, putting 5 percent of their foreign currency reserves into gold since 2005.

But not everyone is gaga for gold.

Andy Brenner, head of emerging markets at Guggenheim Securities says, “Gold is indirectly related to the weakness in currency...specifically the euro. The fear that the EU's $1 trillion package may not be enough has caused a strong bid in gold. Having said that, I think gold is a lousy long term investment.”

Sharon Epperson contributed to this story.

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