Despite High Price Now, Gold's Gleam May Soon Dull for Investors


Gold is trading at a record $1,240 an ounce. Does that make sense? Not if you look at supply and demand, or the likely rise in interest rates soon as the Federal Reserve tightens money supply to fend off inflation while the economy starts to rise out of the Great Recession.

But that high price can easily be explained if you look at the attachment millions of small investors have to the precious metal, spurred on by certain media segments that appear to have been hijacked by gold traders.

Based on supply and demand, gold should be poised to fall. A former student of mine, who now works at a London hedge fund, offers what he calls "some anecdotal evidence on gold supply and demand." He has tremendous access to information about what's driving gold's price, and he doesn't think it makes sense to produce more gold: "From a supply side, it makes sense for a mining company to not produce gold since the present value of gold increases in a low interest rate environment like now."

He believes that gold suppliers are producing way more gold than they ought to be. "The data. . .does not support this view [to produce more]," he says, but "according to [precious metals consultancy] GFMS, gold production has increased enormously in 2010. This should put some downward pressure on gold prices, in theory at least."

Short- vs. Long-Term Arguments

The economic argument on gold pits what hedge funds think will happen to short-term gold demand and supply against the likelihood that the Fed will soon reverse its easy-money policy.

According to my London source, who often gets pitches about investing in gold: "I've been hearing both sides of the argument. I know there are some funds that are holding physical gold in Switzerland because they think there will be a short squeeze in gold in case of another major crisis, and gold futures will skyrocket. I've been hearing others say the gold rally has run its course, and it's time to get out as soon as the core inflation picks up and the Fed signals a rate hike. Obviously gold is traded globally, so any crisis like the one in Greece would push out the gold bust a few quarters."

My source is sympathetic to the argument that a recovery in the U.S. and the rest of the world will damage the case for investing in gold: "I believe in the U.S. and global recovery, so I guess you can put me in the second camp."

Why Glenn Beck Pushes Gold

So why do people keep driving up the price of gold? As I've argued before, I believe there's a gold media complex with some serious hooks into the minds of millions of small investors. How so? Glenn "Passion For Gold" Beck thrives on a paranoid fear of the Fed and its printing presses.

His philosophy is also seemingly tied to his work for a gold retailer who sponsors his show. Beck's basic idea is that the Fed is part of a global banking conspiracy that will use its control of the money supply to print huge quantities of useless paper and then throw everyone in concentration camps as Armageddon approaches.

My London source points out that sadly, Beck's passion for gold has infected even his in-laws: "I'm amazed to see how much effect Glenn Beck has on less sophisticated investors by endorsing gold on his show (and apparently getting paid for it). My in-laws in rural Minnesota are holding on to their gold like the bible 'because Glenn says so.' That's unbelievably sad, and correcting it should be one of the objectives of the new financial consumer protection agency."

When the U.S. recession ends and the Fed starts to raise interest rates, those who buy gold now will likely suffer for their faith in the metal.