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What is driving the price of Gold?

We have all heard the age-old wisdom that gold can provide for a hedge against inflation. The Federal Reserve has recently contended that inflation is not an immediate threat or concern to them. In fact, Ben Bernanke, Chairman of the Federal Reserve, said in a speech earlier this week that “�the U.S. economy still faces considerable challenges but the most likely outcome is moderate growth with subdued inflation.” Despite this, Gold has rallied significantly in 2009 – noticeably in recent weeks. What then is accounting for rising Gold prices?

We, at Hennion & Walsh, believe that it is due to a number of factors. The first factor would have to be the value of the U.S. dollar. As the value of the U.S. dollar has weakened, given record low interest rates, U.S. dollar based investments, such as U.S. Treasuries, have become less appealing to investors – including foreign governments. These investors are now looking to Gold for its perceived safety and return potential.

Secondly, we believe, to a degree, that it is due to traditional supply/demand pressures. The actual worldwide supply of Gold is limited, and, despite the efforts of many mining companies, new sources of Gold ore are becoming increasingly difficult to find. As with any commodity, limited supply and increased demand leads to an increase in price.

Lastly, we do believe that investors, despite the comments of Bernanke and others in the media, sense that the threat of inflation is upon us and the future direction of the market is unclear. This is likely also the reason why we have seen equity and bond markets both rise in recent weeks despite the historical negative correlation that has existed between these two asset classes. For these types of investors, Gold appears to be an adequate investment at this inflection point for a portion of their investment portfolio.

Other metal based commodities are also benefiting from the Gold euphoria. Silver, Palladium and Platinum have also seemingly grabbed onto the coattails of the run-up in the price of Gold. The return of Silver, in particular, which actually has more industrialized uses than Gold, has outpaced Gold by more than 2-times thus far in 2009. To help better illustrate the performance of Gold and Silver in 2009, a chart, which shows the Year-to-Date performance of two ETF’s that attempt to track these two commodities, is provided below.  The two ETFs used in this analysis are as follows:

SPDR Gold Shares Trust (Ticker: GLD)
iShares Silver Trust (Ticker: SLV)

While a rise in U.S. interest rates may strengthen the value of the U.S. Dollar and thus lessen the attraction to metal based commodities such as Gold, we don’t believe that this will happen anytime in the near future and an allocation to commodities, whether through a basket of commodities or collection of single commodities, in most investment portfolios is worthy of consideration.

*The above information is for illustrative purposes only and does not reflect a recommendation by Hennion & Walsh or any of its representatives to buy or sell.

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