Merk Market Outlook: Outlook On Gold: Buying Opportunity and Hedge Against Uncertainty Ahead

By: Joseph Brusuelas | Fri, Oct 24, 2008
Print Email

Perhaps the most interesting development during the intensification of the credit crisis is that the price of gold did not climb higher than it did. Upon the initiation of the crisis in August 2007, the price of gold surged reaching a high of $1002.95 on March 14, 2007. Since then the cost of the precious commodity has fluctuated with the most recent price action sending it to recent lows of 725.74. However, given the pervasive uncertainty in markets we think that this represents a strategic buying opportunity on the back of our bullish call for gold to spike towards $1100 in 2009 with the potential for a much larger move over the longer term.

Given the sheer volume of liquidity that has been pumped into the global economic system over the past year it is an understatement to say the least that the price of gold has trended downward. A look at the adjusted money base of the US indicates that the money supply is up 18.6% year over year. The Fed alone has pumped over 1 trillion dollars into the economy and the US federal government will do well to avoid running a 2 trillion dollar deficit during fiscal year 2009.

The enormity of the steps taken to prevent a complete meltdown of the global banking system will put at risk years of hard won credibility of global central banks and keep the specter of inflation at the forefront of the minds of the investing class. Although, we are currently poised to observe a dis-inflationary moment as the deleveraging that is already underway has ushered in a period of intense declines in the values of assets across just about every class. With the velocity of money in decline, the contemporaneous increase in the supply of money should not stimulate an increase in inflation in the near term. However, over the longer term the independence of the central banks around the world will be severely tested by governments and publics beset by extraordinary levels of debt and increasing rates of unemployment.

Moreover, the increase in the supply of gold will fall well short of the increase in the supply of paper money over the next few years. In the context of a profound economic uncertainty, financial instability and geopolitical turbulence gold will slowly begin to reassert itself as the preferred safe haven of savvy investors, probably at the expense of the US dollar.

The risks to this scenario are two fold. First, the current dis-inflationary moment quickly unwinds and evolves into a Japanese style deflation for the US and the major economic powers, which would depress the price of commodities further and limit the upside on gold. Second, that the financial stress in the EU, Asia and emerging markets could turn out to be more pronounced than that of the US. This could cause the dollar to continue to appreciate, which would limit the upside of the move in the price of gold.

Given the volatility in the price of equities and the uncertainty in fixed income markets over the intent of the Federal Reserve at this time, we are much more confident in the direction of the price of gold over the medium term than we are that of stocks and treasuries. The steps taken by global central banks have begun to thaw credit markets and interbank lending appears to be in the process of recovering. But those, steps may be difficult to reverse and increase in dollar denominate reserves we think is a bullish signal on gold going forward.

The unwinding of positions in a panic and the intense period of deleveraging ahead has stimulated many market participants to move smartly into Yen and quite interestingly, into the dollar as a safe haven moves. Given the stability of the Japanese banking system, the move into the Yen makes sense. However, we see the recent strength of the dollar an understandably reactionary move by global investors after a half-century of a dollar hegemony, to find shelter in a global storm where no safe havens appear to exist and instead have turned to a deeply indebted US government out of habit. Thus, once the tide begins to ebb from the storm and investors can begin to evaluate the extent to which the US, EU and global governments have moved to stem the tide we do expect that gold will replace the dollar as the preferred hedge against uncertainty ahead.

 


 

Joseph Brusuelas

Author: Joseph Brusuelas

Joseph Brusuelas
Chief Economist
VP Global Strategy
Merk Investments LLC

Bridging academic rigor and communications, Joe Brusuelas provides the Merk team with significant experience in advanced research and analysis of macro-economic factors, as well as in identifying how economic trends impact investors. As Chief Economist and Global Strategist, he is responsible for heading Merk research and analysis and communicating the Merk Perspective to the markets.

Mr. Brusuelas holds an M.A and a B.A. in Political Science from San Diego State and is a PhD candidate at the University of Southern California, Los Angeles.

Before joining Merk, Mr. Brusuelas was the chief US Economist at IDEAglobal in New York. Before that he spent 8 years in academia as a researcher and lecturer covering themes spanning macro- and microeconomics, money, banking and financial markets. In addition, he has worked at Citibank/Salomon Smith Barney, First Fidelity Bank and Great Western Investment Management.

Mr. Brusuelas lives in Connecticut with his wife and St. Bernard.

Merk Investments LLC is the manager of Merk Mutual Funds, including the Merk Asian Currency Fund and the Merk Hard Currency Fund. The Merk Asian Currency Fund invests in a basket of Asian currencies. Asian currencies the Fund may invest in include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund invests in a basket of hard currencies. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a hard or Asian currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit www.merkfund.com.

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at www.merkfund.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advise nor a solicitation or an offer to buy or sell any products or services. Foreside Fund Services, LLC, distributor.

Copyright © 2008 Merk Investments LLC

All Images, XHTML Renderings, and Source Code Copyright © Safehaven.com