By Mike Caggeso Associate Editor
The gold bugs must be scratching their heads. After all, it's just not supposed to work this way.
They've watched as oil prices continued to set new records, understanding that global turmoil and rising demand from China means that "black gold" won't be getting cheaper anytime soon.
They've stared as global food prices continued to soar, touching off riots overseas and bringing U.S. lawmakers to the brink of fisticuffs because of debates over whether corn now earmarked for ethanol should be used to fill empty gas tanks, or empty stomachs.
And they've waited expectantly as the good old U.S. greenback - whose historic swoon against key global currencies has been exacerbated by an epic rate-cutting campaign by the U.S. Federal Reserve - suddenly reversed course and mounted a two-week rally (despite last Wednesday's rate reduction, the central bank's seventh since September).
When they occur separately, each of these developments - increasing oil prices, soaring food and commodity prices, and a plummeting greenback - are highly inflationary. But when they happen in tandem, the ascent in prices can be almost vertical. In such an environment, investors scramble to find a so-called "safe haven" for their money. And the best safe haven has generally been gold.
Until now, that is.
Gold dropped below $850 an ounce last week - representing a decline of more than $182 an ounce, or nearly 17%, from the yellow metal's March 17 record of $1,032.
The main culprit: The resurgent U.S. dollar. Since mid-to-late April, the U.S. greenback has gained ground against several major currencies, such as the European euro, the Japanese yen, the British pound, the Swiss franc and the Canadian dollar. And that rally could continue, especially now that the U.S. Federal Reserve has all-but-promised to end the ambitious rate-cutting campaign that it's been operating since mid-September.
But Money Morning contributing editor Martin Hutchinson thinks other forces are at play, too.
"Credit conditions have eased since March because of the Bear Stearns (BSC) bailout and so investors' fear level is less. [The] stock market is up too, which suggests the same," Hutchinson said.
Moreover, gold's meteoric rise from $654 to $1,032 an ounce in a year (a 57.8% gain) attracted a lot of bulls and speculators whose demand helped push prices further skyward. When gold started to slip, gold bulls sold off their holdings, nudging the yellow metal into its current tailspin.
Such a slippery slope is unusual for gold, but those very conditions could be strong drivers of gold's next rally.
"The gold market is quite illiquid, which is why I think a real speculator panic about inflation could send it zooming," Hutchinson said.
And inflation could be the catalyst for such a speculative panic.
Gold may be down from its high, but it's not out.
"It still looks heavy at this point. The downtrend that we are seeing at the moment is probably going to start slowing down soon," Taso Anastasiou, technical strategist at UBS Investment Bank (UBS), told Reuters.
In fact, gold's current price could be seen as a "discounted" entry considering three catalysts - worldwide monetary policy, global supply-and-demand, and past performance - have already ignited a powerful rally that's virtually certain to carry gold past $1,500 this year.
And, as Money Morning has chronicled, some experts have even predicted that gold prices would reach the $2,000-an-ounce level within the next year or so.
Global inflation will be a key -if not the key - factor. Interest rates have been significantly reduced around the world, with many countries following the Fed's lead.
To fight inflation, central banks will have to raise rates. But central bankers - including the U.S. Fed - won't make those moves without a great deal of thought beforehand, Hutchinson said.
"And during that period, expect speculative demand for gold to intensify and its price to increase steeply. The longer the period before the Fed is forced to increase interest rates, the higher gold will go," he said.
Until the Fed reverses its monetary policy strategy and increases interest rates, gold is one of the best investment bets available in an uncertain economic climate.
Money Morning suggests six gold plays to consider while gold is priced down:
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