by Richard Ilczyszyn

Gold has traditionally served as an inflation hedge, but in recent days, gold has become a hybrid asset, with many reasons for investors to own it. It has also historically had an inverse relationship with the U.S. dollar, but wise traders today are watching the stock market, and the euro, for directional clues in gold.

Gold is trading at record highs, but I don’t think it has peaked just yet. As gold approaches $1,250 an ounce, investors seem to get more excited about owning it, not less. They are looking for return for their money, and gold’s prospects look better to investors than many other “safe haven” investments with low yields, such as Treasuries.

When you consider the average price for gold from 1998 – 2008 was about $200 - $400 you can see just how dramatic gold’s move has been. Of course this market has seen many historical spikes. We saw some dramatic spikes in the 1970s tied to inflation, but then as the economic cycle changed, gold settled into a range that lasted many years.

I am looking for about $50 - $60 more upside in the near-term, and can see gold moving above $1,320, However, I don’t see it going to the moon; I don’t think some of the predictions other analysts have made of $5,000 or higher gold are very likely. I think investors will be priced out of the market in that case, and demand will drop. Gold serves not only as a store of wealth for investors, but is also subject to consumer demand for jewelry, watches and the like.

Gold as a Hedge
In the past, gold was used as a hedge against inflation. Today, it is serving as a hedge against a general economic downturn, and against specific assets such as the S&P 500 and/or the euro. The debt crisis in the eurozone and uncertainty over the stock market has spooked investors. Historically, investors would watch the U.S. dollar’s price to determine where gold was headed; since gold is priced in U.S. dollars it would trade inversely. However, today, watching the major stock indexes and the euro provide a more valuable picture.

We can see this relationship between gold and the stock market when looking at the charts of gold and S&P 500 futures on June 9. When the S&P 500 futures traded up to their high of the day near 1,077, gold made its low for the day near $1,223. As equities started to break later in the session, gold came roaring back into its close. This creates an interesting trading opportunity. If equities sell off, gold is likely to slide.

Gold and Central Bank Holdings

It’s important to understand what’s driving gold to record highs As mentioned, gold has been used as a safe-haven by investors in the midst of weakness in the stock market, as well as the euro. The popularity of gold-backed exchange-traded funds has also increased overall interest and participation in the market.

A couple years ago, few analysts had predicted the problems the euro is now facing, let alone that it might fail. We’ve seen news reports of banks with large euro reserves that might be moving their holdings into gold or dollars. I don’t think major players will blatantly announce this fact, however.

Just because something is on the Web, even if it’s reported by a major news agency, doesn’t necessarily mean it’s completely true. But these types of rumors can drive the market up, and we could very well see more institutional investors increase their gold holdings this year. In 2009, central banks were net buyers of gold, according to the World Gold Council. India alone purchased 200 tons of gold from the International Monetary Fund, and they had been net purchasers before.

While it’s been a popular term used to describe gold, calling it a “safe-haven” is a bit tricky because it can be an extremely volatile market. Even if you are correct about the market’s long-term direction, you can take some heat as the market faces corrections off key technical levels. If you are a long-term investor in gold, I recommend you hedge your position. You can work with a professional such as myself to help you develop an appropriate strategy.

Richard Ilczysyn is a Senior Market Strategist with Lind-Waldock. He can be reached at 800-605-0095 or via email at rliczyszyn@lind-waldock.com.

On June 10, 2010, Richard gave more thoughts on gold on CNBC, which you can view here: http://bit.ly/9C6QE9

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