Gold price breaks $500 threshold for first time since 1987

Rally might signal inflation, declining stocks, higher interest rates


There was a time, before national banks and paper currency, that gold - not cash - was king.

As it spiked over $500 per ounce yesterday, the first time it crossed that threshold since 1987, the regal metal that had been relegated to a relic for decades once again laid claim to its throne.

Its message to investors: Watch out for inflation next year. Be particularly careful in the bond market, which signals the direction of interest rates. And, oh yeah, the stock market might not look too pretty, either.

"The price of gold is an early warning of a lot of other things," said David Ranson, research director at H.C. Wainwright & Co. Economics Inc. in Hamilton, Mass. "It's a much more important signal than the vast majority of economists give it credit for."

Since the beginning of the year, gold has been on a steady march to its highest level in nearly 20 years. While it retreated from the psychologically significant $500 threshold to close at $499.10 per troy ounce on the Comex division of the New York Mercantile Exchange yesterday, the price of gold is up 16 percent since January.

That may be good news for gold bulls, including hedge funds and speculators who invest in bullion to diversify their portfolios, but it's not a positive indicator for the markets overall. Along with other precious metals such as silver and platinum, gold has historically served as a reliable gauge of what the future holds for key economic measures such as inflation, interest rates and unemployment.

When gold goes north, the markets turn south.

"The more rapidly the dollar price of gold rises, the poorer performance the equity market turns in. It's a very strong relationship historically," said Ranson, who specializes in commodities. "It's really irrefutable."

Of course, gold's price is influenced by numerous factors, including supply from mining firms, interest from speculators in gold-based exchange-traded funds and worldwide demand for gold jewelry - which was up 55 percent last year and is on pace for an additional 12 percent increase this year, driven by rising demand from India, according to the World Gold Council.

But since the price of gold is measured in U.S. dollars, economists said, any change in the metal's price is as much a measure of investors' confidence in the dollar as it is a barometer of investors' outlook on gold itself.

And with the prices of other precious metals rising along with gold, analysts said, it's much more likely that worries about inflation, rather than demand for bling, are driving investors.

"People are always saying it's the Indians buying more gold, but come on. Is that a new phenomenon? There's no reason to hold gold, which pays no interest, unless you're losing confidence in currencies," said Michael T. Darda, chief economist of MKM Partners in Greenwich. "And if there's a loss of confidence, then the purchasing power of money falls, and that's the definition of inflation."

While other commodities, including oil, also act as early warning signs for inflation, none has the predictive powers of gold, analysts said.

That's because of the metal's unique historic role as a liquid store of wealth.

Unlike other commodities, which are produced for consumption, gold is produced mainly for accumulation - even when it's used as jewelry.

Because it's not an input in industrial production, gold's relative price does not fluctuate with the business cycle.

So, even though the world's currency markets no longer operate on a gold standard, the metal still serves as a haven against the devaluation of paper money: Over long periods, gold's purchasing power has been nearly constant.

"The currency, not gold itself, is variable," Ranson wrote in a recent note to investors. "Thus, for purposes of anticipating inflation one year in the future, there is no significant information in the price of oil that is not already captured by the price of gold."

Whether gold has hit its peak or goes higher is the subject of great debate among traders.

"I see no reason why we don't hit all-time highs exceeding $850. My guess is that $500 will look low going down the road," said Rob Lutts, chief investment officer of Cabot Money Management Inc. in Salem, Mass., which has about $350 million under management.

But analysts warn that betting on a further rise in gold prices is tantamount to betting against the Federal Reserve, which has committed to fighting inflation by raising interest rates - at which point the price of precious metals could retreat.

It doesn't so much matter where the price of gold goes from here, analysts said, as does knowing where gold has already been.

The fact that the metal has crossed the $500 mark - not a magic number in itself but important when considering the sustained run-up this past year - says that the real value of currencies is on the decline.

Ritu Kalra writes for The Hartford Courant.

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