Gold flirts with $1,700 an ounce but won't commit

By John Waggoner, USA TODAY
Gold is going gaga again, thanks to new worries about inflation.

Gold futures closed Tuesday at $1,693.60, up $8.30. Gold's record high was $1,888.70 an ounce, set a year ago.

Gold gains when paper money loses value, either through inflation or through the currency markets. Inflation fears heat up when central banks try to stimulate the economy by reducing interest rates or increasing the money supply.

There could be plenty of stimulus in the pipeline: This week, European Central Bank President Mario Draghi is expected to announce new measures to buy European bonds, which will help reduce interest rates in Spain and Italy and stimulate the European economy.

At the same time, the Federal Reserve is expected to start another round of stimulus, called quantitative easing, later in the fall. In quantitative easing, the Fed buys bonds and other securities with newly created money.

"It's all the central banks lined up with bazookas of money," says Dan Denbow, manager of USAA Precious Metals and Minerals.

The central banks may be coordinating their stimulus policies, says Doug Groh, manager of the Tocqueville Gold fund. "It can't be just one central bank to try and save the world," Groh says.

Furthermore, U.S. politicians don't seem to be growing more fiscally responsible. For example, as the elections approach, so does the so-called fiscal cliff: a combination of tax increases and spending cuts that will go into effect on Jan. 1 if Congress doesn't act.

Groh thinks Congress will figure out some way to pull the nation away from the edge of the cliff, but not before scaring investors and consumers alike. "It will freak everybody out," he says. "Gold thrives in that type of environment."

Despite inflation fears, there's little evidence of actual inflation. The consumer price index, the government's main gauge of inflation, rose 1.4% the 12 months ended July.
Gold production rose 2.8% in 2011, according to Thomson Reuters. That could slow further this year, thanks to rising production costs. "Capital costs have blown out in the mining sector in general," says Groh.

But investment demand for gold should grow. "The long-term story for gold is global currency debasement, unless lawmakers make some hard decisions," says Denbow. "We haven't seen lawmakers willing to make hard decisions."

USA TODAY