Investing in Gold During a Fed-Induced Bounce

Stocks up, gold down.

Once again yesterday, investors demonstrated their preference for paper over the shiny yellow metal. The Dow Jones Industrial Average notched a slight 3-point gain, while gold tumbled about $17 an ounce.

This divergence between stocks and gold is not enormous, but it is telling. Most investors believe the credit crisis is a mere memory, and that an economic recovery is underway.

Your editor is not persuaded by this conventional wisdom. As a homegrown Californian, your editor is as eager to embrace a feel-god vibe as anyone. But this particular vibe doesn’t feel that good…or logical.

The worst of the credit crisis may have passed, but serious credit problems continue to beset the US banking system. Everywhere you turn you see an impaired loan dressed up like an Academy Award nominee.

And the economic recovery that so many folks pretend to see is nothing more than a mirage wrapped in a chimera. This so-called recovery is not a recovery at all; it is a Fed-induced bounce from “superbad” to merely bad.

Your editor is not buying this storyline, dear reader.

If he were buying anything at all he would be buying gold and/or the shares of companies that haul monetary metals out of the earth. No matter whether the US economic recovery is real or not, the tsunami of cash and credit that the Fed has unleashed on the US economy is very real…and the consequences are likely to be very inflationary.

But even if this logic eludes the Ivy League educated minds on Wall Street, it does not elude the minds that control the national balance sheets of India and China.

“On February 24, Reuters reported that the Reserve Bank of India was ‘set to be a buyer’ of the 191.3 tonnes (6.74 million ounces) of gold the IMF is selling,” reports Jeff Clark, Senior Editor, Casey’s Gold & Resource Report. “Although the bank wouldn’t comment directly on the possibility, they did say, ‘We are closely looking at the gold market…gold is a safe bet.’

“The article then quoted an unidentified official from the China Gold Association as saying, ‘It is not feasible for China to buy the IMF bullion, as any purchase or even intent to do so would trigger market speculation and volatility.’

“But the next day,” Clark continues, “Finmarket news agency in Russia reported that China ‘confirmed its intention’ to buy the IMF gold. ‘Chinese officials have confirmed previous announcements from IMF experts and said that the purchasing of 191 tons of gold would not exert negative influence on the world market.’

“While they’ve been silent since,” says Clark, “both India and China have publicly hinted they want this latest batch of yellow bars from the IMF. There’s no way to know if a competitive bid would spring up between these two countries, but…can you imagine the ramifications if one did?

“When India bought 200 tonnes of IMF gold last November 3, it set off a buying spree that saw gold rise 14.2% in 4 weeks. What if this time around, a couple central banks both want the gold for sale? What if China says to India, ‘Not so fast, guys. We’d like to bid on that, too…’ and word of that clash leaked out?

“Pure speculation, of course,” Clark concludes, “but competing for gold purchases isn’t a far-fetched idea. This sale is not pre-arranged; it’s an open market sale. Also, there’s only so much to go around. These two countries have only a tiny amount of their reserves in gold. Throw in the fact that central banks worldwide are already net buyers. A pretty intriguing thought, wouldn’t you say?”

Yes…quite.

Eric Fry
for The Daily Reckoning