Among the world’s gold bulls, investment in the yellow metal seems to be the answer to all evils and in times of financial and political crisis, as at the present, they may well have a point.  Whether it is protection of one’s wealth against inflation or against deflation – two diametrically opposed potential consequences of the current global financial breakdown (and fears of the former seem to be changing to perhaps the even more worrying latter possibility) – both seem to be assessed to be positive for gold.  Or at least less negative for gold than for most other investments.

While gold has hardly been seen to be performing well in recent months, and has failed to meet gold optimists’ more extreme, or even more mild, expectations, it has still performed less badly than most other sectors of the market.  As has been noted here on several occasions actual physical demand has remained extremely strong, both in eastern and western markets.  Major gold suppliers have run out of inventory and seem to be having difficulty replacing it, while ETF demand remains very positive.

The price overall though has not powered ahead as would seem the likely result of this scenario.  The gold bulls cry market manipulation by Central Banks and their allies – and a huge gold price surge may well not be in their perceived best interests in trying to keep world currency parities under control – while others look to liquidity problems faced by other gold holders faced with a collapse in markets in general as the reason for the seemingly poor performance of the metal.

In his latest Gold Brief, Jeffrey Nichols of American Precious Metals Advisors says Gold bulls are separating into two camps – inflationists who see gold as a hedge against future inflation and a decline in the U.S. dollar’s purchasing power . . . and deflationists who see gold as a deflation hedge as money seeks safe harbor in cash and cash equivalents like gold. 

“I believe we will see a longer, deeper decline in business activity than most, lasting into late 2009 or, more probably, 2010 – and likely to be accompanied by some of deflation, particularly in commodities, food, autos, and a variety of consumer goods.  To be honest, deflation has been with us for some time already, first in real estate markets, then on Wall Street, more recently in oil and commodity markets, and, as anyone shopping for the holidays will soon notice, in many retail stores.

“But as the economy revives – as it must with massive and unprecedented Federal government stimulus – prices for many goods and services will shift from reverse to forward . . . and inflation will replace deflation as all those trillions of dollars come home to roost.”

The recent mini-surge in the gold price seen just ahead of the weekend has been taken as a sign of further US interest rate cuts ahead, but could also suggest that the liquidity problems faced by investors in the metal are gradually unwinding and forced sales may not continue at the same rates.  But the price seems to be drifting again and this could prove to be yet another false dawn.

Once again there is talk of the Chinese Central Bank switching an important proportion of its huge surplus into gold, but in terms of the volumes suggested by those who promote this idea, this would be incredibly destabilising with gold surging to huge levels and a collapse of confidence in the dollar which is probably not in China’s best interests anyway, and the powers that be will be well aware of that.  However there could be a gradual building of gold into Chinese reserves which would be positive for the market.

Nichols points out again though that there is a gradual liberalisation under way in China with regard to personal gold holdings which, with the eastern propensity to hold gold, could also be beneficial to the market.   But again a huge surge in the gold price would be counter productive as demand would probably dry up quickly to be replaced by profit taking.

So, it may well be a case of ‘steady as she goes’ for the immediate future of the gold price.  Rises followed by drift and consolidation.  The likely overall trend is up, but perhaps not rapidly and yes, gold probably will remain one of the better ways of preserving one’s wealth, but the market remains unpredictable so it is probably best considered one of several tools which can aid financial survival over what are surely several difficult years yet to come.