Long-Term Investments – Is it still a good idea to own Gold?

“High and rising emerging-market demand levels against limited supply growth in key commodities are likely to increasingly tighten balances.” But the analysts also added that “the current softness in economic data, combined with increasingly mixed signals from the underlying commodity markets, is likely to continue to generate choppy price action in the near term.”

Commodities capped its declining performance last week after the Federal Reserve announced that recovery is weakening. Reports further indicated that China’s industrial production, sales, and new lending grew at a slower pace in July; European industrial output also fell. As a result, Goldman Sachs slashed its 12-month forecast for gains to 19% from 21.6% in the S&P GSCI Enhanced Total Returns Index. This index lost a total of 4.9% last week.
Commodity Prices May Continue to Rise in the Long Run

If Federal Reserve pronouncements are correct, deflation is the next threat to the economy. Looking closer though, it becomes clear that this statement does not show the entire picture. The price of gold is still hovering at $1200 and up. Analytical investors are predicting inflation.
Gold prices, which reached a record high of $1,265.30 an ounce in June is now trading at $1,229 as of August 18, 12% higher since 2010 began. In fact, Goldman Sachs even predicted that gold will reach $1,300 in six months on renewed investor interest. The price of this precious metal, which has been rising for nine years, may climb further in 2011.

Meanwhile, New York crude futures remain relatively stable at $75.27 a barrel; 5.1% lower since the start of this year. However, the price is expected to increate toward the end of the year on expectations of higher Chinese demand and the decline in crude stockpiles in both the United States and Europe.
Inflation and the Worrying Depreciation of the Dollar

Many investors have learned a hard lesson by taking Fed announcements at face value. Aside from Federal Reserve reports, it may be a good idea to look at other indicators. For example, the Congressional Budget Office (CBO) has released a report entitled “Federal Debt and the Risk of a Fiscal Crisis” on July 27, 2010. It cautions against excessive federal government spending.

The historical data of US federal debt throughout US history showed that debt reaches new highs during economic disasters and wars (i.e. Great Depression and World War II). Right now, the debt held by the public – and increasingly foreign governments and investors – has surged from 36% of GDP at the end of 2007 towards a projected 62% at the end of this year. The Washington Post reports that “Policy options for responding to it would be limited and unattractive”. There are several options to take of the debt problem including currency inflation, implementation of austerity programs, and debt restructuring.

Based on the findings of CBO, there will be limited options that are favorable. This is because the Fed has already overstretched its resources in the financial rescue package before.

· Debt Restructuring – the terms of the $13.5 trillion debt can be renegotiated. It can lead to a longer maturity date, changing the rates, or outright default. As it stands right now, outright default may sound infeasible. But the Asian currency crisis and the LTCM hedge fund provides hard-earned lessons for investors.

· Austerity Program – a program that combines lower spending through less entitlements and higher taxes are both required to make an austerity program effective. An austerity program would be painful for people who rely on Medicare, Medicaid, and Social Security especially if the age requirement for these programs is lowered. Slashing 15% off entitlement programs is believed to be the minimum necessary to avoid fiscal crisis.

· Inflation – increasing the money supply will make debt a lot faster to pay off. However, in inflation, the amount of money to be printed should be carefully determined to mitigate its impact on the economy. Deflation is the one thing to be avoided because prices and wages will fall, making debt more difficult to pay.

The problem with this picture is that there is no political will to address the crippling liability. If there is even a talk of renegotiating the debt or default, the dollar and the bond market can potentially collapse. The only option left in this regard is inflation – but to feel its effective, money supply should increase dramatically. Inflation steals the earnings of an average American citizen but it will pay for the government debt.

Inflation Might Be the Only Real Alternative for the US

Both France and Germany used inflation as a way to pay off debts after World War II. It was difficult for citizens but it allowed the country to regain its competitiveness. Inflation enabled their exports to become more attractive due to lower currencies. In the case of Germany, it also helped in the renegotiation of war reparations.

In today’s crisis, both Europe and the US are in financial trouble. But while Europeans are solving their debt problems through austerity measures, it is increasingly becoming clear that the US will not follow suit. Instead, it will follow the German model of severely inflating the currency. Federal Reserve Chairman Ben Bernanke understands that inflation is easier to control than deflation.

Dramatic increase in the money supply benefits the country’s economy by the simple act of printing money. But a large percentage of the population will experience a lower standard of living because of it. But inflation shouldn’t be seen as an ideal solution. It does have its cost. In fact, a 1% increase in inflation will lead to a $.7 trillion increase in debt.

Despite the issues that will be posed by inflation, deflation is an even worse alternative. Deflation is unpredictable and there is a limit on how much control you have over it. As it stands and after the stimulus spending that has been injected into the economy, the country is still not seeing inflation. In fact, it is difficult to determine if the US is experiencing inflation or deflation. But many predict that inflation will win out in the end.

In the last 4 years, money supply has been doubled. The immediate debt may be $13 trillion but the long-term debt is already placed at $100 trillion. Tension is high in the market. At the first sign of a sustained price increase, millions will start to re-inject their dollars into the economy.

Inflation can get out of control and if it does there will be only one question that will separate those, who will have lost their wealth and those who will have managed to increase it – did we buy gold and silver? Make sure that your answer is yes. If your answer is positive than perhaps you could use our assistance – especially if you would be interested in earning profits along the way through speculative transactions in gold, silver, and/or mining stocks.

Please note that the above essay reflects long-term trends – not short-term moves that could also be successfully traded. If you are interested in the latter, we encourage you to subscribe today and read today’s Market Alert with our most up-to-date trading suggestions.

Thank you for reading.