Fear, uncertainty are driving latest gold rush

Image: A goldsmith displays gold bangles in his jewellery shop in Istanbul
A goldsmith displays gold bangles in his jewellery shop in Istanbul April 22, 2011. Spot gold has surged to a lifetime high, hitting a record for a sixth consecutive session on a weak dollar and factors ranging from geopolitical uncertainty to inflation concerns.MURAD SEZER / X90138

Uncertainty about the economy's strength, fears about rising prices, worries over global instability. Investors are facing an onslaught of headlines, from inflation to turmoil in North Africa, that is driving them into the arms of gold.

The precious metal blew past $1,500 an ounce this week to record levels in dollar terms, rising for six straight sessions. The precious metal is still trading below its inflation-adjusted peak of about $2,200 an ounce, however.

There are no guarantees that gold prices will keep rising from historic levels. For now, though, just about all the forces that have traditionally pushed gold prices higher are in place.

The steep price rise of the past year leaves little doubt that investor psychology is playing a major role. Gold is seen as a safe haven for a wide variety of forces that destroy paper wealth. And there is no shortage of scary headlines to choose from.

The list starts with gold buyers' worries about inflation, sparked by the Federal Reserve's unprecedented policy of flooding the U.S. economy with more than a trillion dollars to try to offset the lingering damage from the financial collapse of 2008. So far, consumer inflation as measured by the government's Consumer Price Index remains relatively tame. But rising prices for commodities such as food and oil have added to fears that the Fed's easy-money policy will produce a wave of inflation down the road.

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The U.S. central banks' policy is designed to keep interest rates low; cheap credit typically encourages borrowing, which stimulates econommic growth. But those low interest rates also make other forms of saving less attractive. Gold prices have risen more than 6 percent this month alone; roughly double what you can get from holding a U.S. Treasury bond for a full year.

Gold buyers have also been spooked by a series of events that are well beyond the control of the architects of U.S. monetary policy.

"Gold's attractiveness as a safe haven has been reinforced by destabilizing events such as the euro-zone's rolling fiscal crisis, the earthquake off the coast of Japan and political upheaval in North Africa," according to Capital Economics analysts John Higgins and Ross Strachan.

Worries about Washington's failure to get control over the U.S. budget have battered the dollar, which gold buyers fear is headed lower still.

Those fears have intensified recently as politicians have made a political football out of an upcoming vote to raise the limit of the government's borrowing authority. Republicans are demanding tough measures to cut spending before they'll agree to grant the Treasury the power to issue new debt once the current limit is reached in July.

Doubts about the prospect of a deal in time to avert a default recently prompted Standard and Poor's to downgrade its outlook on U.S. debt for the first time in the rating agency's 150-year history.

Gold's seemingly relentless rise has also become self-reinforcing, as a surge in investor demand tightens supplies and forces prices even higher.

Since it last peaked in 1980, gold has become easier and cheaper to acquire. Individuals — who once faced the prospect of stashing away gold coins under their mattress or paying a dealer to store their gold bars — can now buy exchange traded funds that offer shares backed by physical gold. Gold has also become a more widely used hedging tool for professional investors, further driving up demand.

So it's no surprise that Wall Street analysts have jumped on the gold bandwagon lately. Goldman Sachs recently issued a note to clients predicting gold prices will hit $1,690 over the next 12 months.

Even if gold keeps climbing, it won't necessarily get there in a straight line, especially after its recent surge.

"Gold is likely to consolidate around the $1,500-level next week," said Li Ning, an analyst at Shanghai CIFCO Futures. "The angle of the recent rally is very sharp, and we are bound to see some correction in the near term."

Predicting where gold prices are headed longer-term can be perilous. The last gold peak came in 1980, when the Great Inflation of the 1970s was still burning out of control. The price of an ounce of the shiny metal hit $850 in January 1980, before crashing below $500 just three months later.

It took another 27 years before the price of gold climbed back to $850 an ounce. Adjusted for inflation, it has yet to recover that peak price.