Gold Directions?

As we discussed in previous postings - physical gold and gold producing companies have traditinally been a great way to hedge against inflation.

Today we see on Kitco gold is about $902 (at the time of this post).

From Reuters this morning we find out there's more supply shortage due to power problems in South Africa - the major source of platinum (75%) in the world.

http://africa.reuters.com/wire/news/usnBAN851431.html

The metals had already been firmly underpinned by supply issues linked to South Africa's power problems and the prospect of a miners' strike next month.

"When you have 75 percent of the world's platinum produced in one country and you have power problems there, that is going to be explosive in terms of price action," said BNP Paribas analyst David Thurtell.

Again, the concept of supply and demand kicks in - boosting prices of the two metals up on pending supply shortages.

What does this have to do with gold, you ask. If you remember we covered how inflation essentially means the devaulation of your dollar either through a few ways:

1) Rising cost of goods and services - consumers can now afford less - CPI rises
2) Decreasing wages - slowing economy - means dollar supply in consumer's pocket goes down
3) Trade deficits - country's buying more exports and selling less - results in a weaker currency as the foreigners start collecting a large pool of your currency. If they decided to exchange most of it back in the market all at once (theoretically) - it floods the market and lowers the value of your dollar.
4) Lower interest rates - means less interest in the dollar - lowers demand even further

In this case dollar can no longer afford to go lower - Bernanke has cut rates 7 times since late 2007. More cuts will erode the dollar and banking system which they cannot do. Banks leverage themselves on loans and live on the spread - when variable rates are this low the profit margin shrinks further - and 2008 is a year when profit is hard to come by for most banks.

If the rates go up - an interesting question will be where gold stands (as its commonly accepted that it goes the inverse direction). Reuters offers some guidance below:

The precious metal is struggling to find direction as the market debates the next move for the dollar. Gold typically moves in the opposite direction to the dollar, as it is bought as a hedge against weakness in the currency.

However, demand indicators are positive.

The world's largest gold exchange traded fund, StreetTRACKS Gold Shares, said it saw a 2 percent or 12.27 tonne inflow on Tuesday, bringing its total holdings to 617.48 tonnes, their highest level since April 22.

Gold ETFs issue securities backed by physical stocks of the precious metal which can be traded on exchanges, allowing investors to gain exposure to metals prices without holding the metal itself.

A rise in ETF holdings has represented a key source of demand for gold since the launch of the first precious metals ETF in Australia in 2003.

There are also signs that Middle Eastern jewellery demand may be picking up, with Dubai gold sales for May rising 18 percent from the previous month as easing prices brought buyers back to the market.

Versus other base metals, gold and silver have an unique trait - they can act as an alternative to currency and their intrinsic value is not based on a promise from a government. Mr. Jim Sinclair might be negative at times, but keep in mind he has been right several times in the last few decades!

With notional value of derivatives outstanding plus listed and OTC derivatives now over a QUADRILLION dollars, inflation is unstoppable by any manner of policy. Interest rates are as ineffective on the upside as they were on the downside. This mess is a derivative mess whose growth will never stop as the more problems occur, the more derivatives are written to combat them. Banks with 1% cash have to raise money or die.

What do you want, a piece of paper with a promise to repay in nothing, or gold?

There is no cogent argument that holds water other than a geometric rise in gold.

With low consumer confidence and overall market chaos - I think it's clear that gold and gold stocks still offer a great alternative to holding onto actual currency.