COLUMN-Gold still not the best inflation fighter

Tue Jul 16, 2013 3:59am EDT

By John Wasik

CHICAGO, July 16 (Reuters) - As U.S. interest rates have risen, owning gold has been a loser's game for anyone is trying to hedge against inflation.

Gold isn't a smart inflation hedge, but many people have been using it that way because they think they have few alternatives.

A low-inflation rate has been punishing to gold investors for the past three months, and the Consumer Price Index has been running well under 2 percent this year. As evidence, the leading gold bullion vehicle, the SPDR Gold Trust ETF, has lost nearly a quarter of its value over the past year as investors continue to sell out of their positions. It was down 23 percent year to date through July 12.

Stocks of gold-mining companies, which can get bruised even more than spot metal prices, have fared worse. The Market Vectors Gold Miners ETF, which holds leading mining companies such as Barrick Gold Corp and Newmont Mining Corp lost nearly half of its value year to date, off 47 percent.

To be fair, gold prices have rebounded in recent weeks. Gold reached a near three-week high after Fed Chairman Ben Bernanke hinted that a highly accommodative policy was needed for the foreseeable future. But, at around $1,285 per ounce on Monday, gold is no where near it's high of $1,889 in 2011.

AN ALTERNATIVE TO GOLD

Will the Federal Reserve's cheap-money machine slowdown ratchet up interest rates even more? A distinction needs to be made: The tapering of its "quantitative easing" programs may or may not lead to inflation. Nevertheless, rising rates - and a resulting stronger dollar - hurt gold bullion, which doesn't pay dividends or interest.

One of the biggest downers for gold owners - in addition to plummeting prices - has been the popped-balloon idea that significant inflation was threatening the U.S. economy.

Since the 2008 meltdown, the United States has been in deleveraging mode, which is disinflationary. Wages have been stagnant and consumer prices tame. Gold rarely makes sense in a low-inflation, slow-growth economy.

Perhaps investors woke up to that fact en masse over the past three months when it became apparent that the Fed said it was more confident that the U.S. economy was firmly on a sustainable path. By June 28, gold had posted its biggest quarterly loss on record - falling 23 percent to $1,180.70 an ounce. It is currently trading at $1,282.10.

Outside of money-market funds and floating-rate bank loan funds, which I've covered in an earlier column (see), a useful and less skittish way to hedge inflation is through Treasury inflation-protected securities (TIPS) funds.

While TIPS yields are also lackluster in a low-inflation environment, they can better protect against longer-term inflation expectations. Because they are indexed to a well-known index that tracks consumer prices, they are much less volatile and boost yield when inflation rises.

The iShares Barclays TIPS Bond fund, which I hold in my 401(k) account, holds inflation-indexed bonds. With a 4.7-percent annualized return over the past three years, it's returned more than twice what the SPDR Gold Trust has offered, which has gained only about 2 percent over the same period.

Year to date, though, the iShares fund has been disappointing, showing a 7 percent loss, which compares favorably to the 23-percent loss posted by the SPDR gold fund.

Why would I recommend a fund that's lost money? Because I think that although short-term inflation fears have been wrong, prices will gradually accelerate across the board as the economy heats up in coming years.

Now's the time to buy TIPS, not when inflation is in full force. If the economy continues on its upward trajectory, prices usually follow. The latest U.S. jobs report showed employment growing faster than expected - nearly 200,000 new jobs were created in June.

So far, though, inflation hasn't been a problem. The latest Consumer Price Index report pegged the annual inflation rate at 1.4 percent through May. Last year the gauge was under 2 percent. You have to go back to 2007 to see the highest annual cost-of-living change since the 1990s (4 percent). Note: That was just after the housing market peaked, but before the credit bubble burst.

Despite the recent rebound in gold prices - the metal posted gains over four days last week - the double whammy of the dollar's rebound and U.S. interest rate increases will make gold even more undesirable. Goldman Sachs cuts its forecast for 2013, predicting gold will end this year around $1,300 an ounce - down 9 percent from a previous forecast.

Goldman stated that gold prices will continue to drop "given our U.S. economists' forecast for improving economic activity and a less accommodative monetary policy stance."

Although there's still a lively debate on whether inflation will manifest itself to any large degree in the near future, gold won't have much luster if rates climb and dollar gains continue.

Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.