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Gold, a Fool's Choice? Hedging Against the Fed's Quantitative Easing

NEW YORK (MainStreet) — Gold, a classic safe haven, is an expensive choice as a rainy day fund to hedge against inflation with prices more than 50% higher than prior to the 2008 meltdown.

The price of gold bullion rose after congressional testimony from Federal Reserve Chairman Ben Bernanke earlier this month, who said the U.S. central bank had no timetable for slowing its stimulus.

"A lot of people hold gold as an inflation hedge, but movements in gold prices don't predict inflation very well, " Bernanke said during the Senate Banking Committee. "Nobody really understands gold prices and I don't pretend to understand them either."

One of the downsides for gold owners has been the idea that significant inflation was threatening the U.S. economy. Over the last year, bullion has slipped more than 20% - losing its safe-haven appeal after the Fed signaled in June that it would being tapering its $85 billion in monthly asset purchases later this year.

 

The price is gold cracked the $1,300 barrier this week but is no where near the metal's record all-time high in September 2011 when it traded at around $1,920.

Investment firm Goldman Sachs even cut its 2013 year-end price target to $1,300 from $1,435 in June and lowered its 2014 prediction to $1,050 from $1,270.

"The U.S. dollar and gold used to be the save havens in the market," said Ulrich Leuchtmann, director of FX at Commerzbank Bank in Frankfurt. "But, at the moment, gold does not behave like a safe haven if you believe that this monetary policy would cause inflation."

The market has been bullish lately for the U.S. dollar with the greenback gaining against other currencies, rallying against the Euro and the Japanese Yen.

"From my point of view, we expect a further trend of the U.S. dollar strengthening against the Yen and the Euro," Leuchtmann said based on short-term data and current monetary trends. "If you believe in the U.S. performance than it's a good place to be."

Contrarian investors are holding on to the precious yellow metal and on to other non-U.S. currencies to hedge against soaring debt.

"When the dollar is strong, we want to sell, " said Axel Merk, president of Merk Investments, a currency and gold investment firm based in Palo Alto, Calif. "In the next five to ten years, historically, we will have higher interest rate and the dollar does not tend do as well."

Merk expects "odd behavior" from the U.S. dollar in the coming months and relies on gold, because it has very little industrial use other than its classical usage as an inflationary hedge.

"The reason why we like gold is there is just too much debt in the world," Merk said.

Gold as a protection against inflations , but rarely makes sense in a low inflation, slow growing economy. The U.S. has been in a de-leveraged mode with the current monetary policies with little inflation and stagnant wages.

"When inflation rears its ugly head from all the debt and a devalued dollar, gold is still the best hedge," said Daniel Denbow, portfolio manager for metals at USAA Federal Savings Bank.

The precious metal is still a hedge although the U.S. dollar is performing better than other currencies.

"Even if gold prices are higher than it was five years ago, the amount of printing of central bank has gone up," Denbow said. "So, you're countering to devalued currencies around the globe."

Demand has continued for gold in the markets on the fiscal side although it is far from the Matterhorn peaks of 2011. Different asset classes, such as gold, perform differently depending on the economic climate and the pace of inflation.

"The key is to invest in a wide range of funds that address different environments," Denbow said for his recommendation for a rainy day fund. "Look at real estate, stock and other areas to provide inflation protection."

--Written by Farran Powell for MainStreet

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