Now Is Not the Time to Be a Gold Bug

The price of gold in the last few days has risen to more than $400 an ounce for the first time since Sept. 30, 1983. Its ascent has been rapid--two months ago gold was at $345 an ounce, and one month ago it was at $360. Why is gold rising?

Because foreign nations that have huge supplies of U.S. dollars are buying it. The foreigners are turning to gold instead of continuing to watch the value of their dollars decline in the foreign exchange markets. Significantly, gold’s sharp upward movement this week followed the release last Friday of the latest dismal figures on U.S. trade. Continuing trade deficits argue for the dollar to fall further.

Accordingly, the Japanese government--the biggest foreign holder of dollars--has been the biggest buyer of gold in the current rally. The Japanese central bank says the gold is needed to mint a coin commemorating the 60th anniversary of Emperor Hirohito’s accession to the throne. But nobody believes that is the whole reason. The Japanese are buying gold because they want out of the sinking dollar but don’t want to buy their own currency and hurt Japanese exports by forcing the yen’s value even higher than it is.

Refuge From Declining Dollar

Other overseas holders of the dollar are similarly buying gold as a temporary refuge from the volatility of the currency markets.

“A lot of the buying now is coming out of Zurich,� says gold watcher Martin Armstrong, who runs a Princeton, N.J.-based economic advisory service. Swiss banks often act for Middle Eastern customers.

Other reasons given for gold’s rise include unrest in South Africa--producer along with the Soviet Union of most of the world’s gold--and the specter of renewed inflation.

Economists are divided on the inflation issue. Pierre Rinfret, an economist who has advised both Republican and Democratic administrations in Washington, thinks that the budget deficit is out of control, that protectionist legislation this fall is a real threat and that we’ll see 10% inflation by 1988-89. On the other hand, economists Michael Drury of New York’s A. Gary Shilling & Co., and John Hekman of California’s Claremont Economics Institute, believe that deflation remains the dominant force in this decade. They see no big increase in wages or prices changing an environment in which inflation has been only 1.5% or so in the last year. On the contrary, they see interest rates continuing to decline.

Will Inflation Return?

So, you’re asking, on which hand is it? Will inflation return as bad as the 1970s, making a mockery of savings accounts and tricking bond investors? Will gold again hold its value, as it did when it rose to a peak of $875 an ounce in 1980? In words of one syllable, is this a good time to buy gold or is it not?

On balance, no. Think clearly about the price of gold itself, and try not to be confused by background issues--inflation returning, South Africa burning. Gold is up strongly now because holders are forsaking the falling dollar. But, for one reason or another--better U.S. trade, foreign economies recovering--the dollar is likely to stop falling and turn around soon, probably within a month. When it does, the market’s logic is for gold to move back down--perhaps to the levels of early July, which is about where gold has sold for the last two years.

And don’t be worried when inflation rises slightly--to levels of 2.5% to 3%--as it is likely to do when and if Japan and West Germany get their economies moving. Remember, their speeding up will help end the malaise that the U.S. and world economies find themselves in today. Better times in the world economy and a rising gold price seldom go together.

As for South Africa, its troubles are not really affecting the gold price. Current gold production of fewer than 50 million ounces a year compares to more than 1 billion ounces held by the world’s central banks, plus hundreds of millions more in private hands.

Finally, don’t forget this is not the 1970s, when people were slow to realize that interest on their savings, from the bank or even the money-market funds, was not keeping pace with inflation. Gold rose only slowly from 1975 to 1978, while double-digit inflation raged, and its price only crossed $400 at the end of 1979, after the second oil shock sent inflation spiraling.

Today, by contrast, interest on savings is staying ahead of low inflation, and the oil price is half the level of a year ago and weak. Yet the price of gold crossed $400 this week. Gold a buy? It might even be a short sale.