Gold investments rising with uncertainty about U.S., global economies

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

That gold has taken more than 17 years to get back to that level - and just as Greenspan is on the verge of retiring - may end up being merely an interesting factoid of his career. Some die-hard fans of the metal, however, believe that the highest prices since the late 1980s must hold an important message about the economy the Fed chief is leaving his successor.

Other than for jewelry or coin-collecting purposes, the purchase of gold often is equated with a rising level of fear among investors. If people are trading in their cash for an ancient commodity, it suggests some erosion of faith in the modern financial system.

Is it inflation that's worrying people? Or deflation? Or the prospect of a global economic crash that would lead to the ruin of paper currencies?

Or is gold gaining largely because it has caught the attention of hedge funds and traders with short attention spans who are quick to jump aboard any rallying market, and who don't care much what the trigger was?

Wall Street has taken note because the metal's latest surge has lifted it almost $40 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 rally between 2002 and 2004: The dollar's value was sinking against other major currencies. If 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 many investors and jewelry buyers overseas, especially in booming economies like India's.

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 jump 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, economist at Northern Trust in Chicago, poses the question 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?" he asked.

Even if that pass-through were to happen 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 scene for gold's record price of more than $800 an ounce in 1980.

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

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

Deflation, or a general decline in prices of goods, services and financial assets, is what Japan lived through in the 1990s. If investors started to fear 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 kind of environment.

Indeed, any kind of economic calamity that would make people question the viability of paper currencies, particularly the dollar, would most likely be great for gold, at least initially. To go 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 around the corner. If that day comes, let's face it - you'd probably be smarter to own shotguns and canned goods than gold bullion.

Jim Melcher, president of money management firm Balestra Capital Ltd. 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 United States is overstretched financially because of its huge 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 said. "You've got to invest where there's growth."

That's harsh, and many trillions of dollars of investment in the United States say Melcher is wrong.

Even so, consider what the average U.S. mutual fund investor has been doing this year: 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.

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