Deflation or not, gold&#39;s fans see reasons to buy

Gold has climbed to within shouting distance of its record-high price, as investors and traders have turned back to the metal amid growing signs of global economic weakness.

Gold?s latest rally has frustrated some bears who expect the economy to fall into a deflationary cycle -- which, in theory, would be bad for classic inflation hedges like precious metals.

The possibility of deflation clearly hasn?t deterred gold buyers in recent days: Near-term futures in New York jumped $17.30, or 1.4%, to $1,214.80 an ounce on Thursday, a six-week high and the biggest one-day gain since June 17.

That left the price 3.4% below its record close of $1,257.20 on June 18. It's up 11% year to date.

Gold lost ground for much of July as Europe?s financial-system crisis faded and the mood about the global economic outlook improved, boosting the euro currency and stocks and reducing demand for precious metals as a place to hide. The price hit a three-month low of $1,158 on July 27.

But gold has rebounded since then as U.S. economic data, in particular, have been weaker than expected and the fear level in financial markets has escalated. That fear bubbled over Wednesday, when stocks plunged worldwide. Equities lost more ground Thursday, although selling was more muted.

If you assume that there is at least some fundamental investment reasoning driving gold (as opposed to just short-term trading strategies), what might be motivating buyers now?

Some may figure that even if deflation happens -- meaning a broad-based, sustained decline in prices for many goods, services and assets -- gold would hold its value better than a lot of the alternatives.

A second idea is that gold buyers just want something tangible in their portfolios at a time of nerve-racking economic uncertainty.

But the most popular line of reasoning among many gold bugs is that the Federal Reserve?s continuing efforts to combat deflation, by driving interest rates lower and by allowing massive sums to slosh around the financial system, will eventually lead to rising inflation and debasement of paper currencies.

A report from Goldman, Sachs & Co. helped stoke Thursday's rally in the metal. Goldman said it expected gold to rise to $1,300 in six months (a 7% gain from the latest price), underpinned by super-low U.S. real interest rates.

None of this impresses critics like Vanguard Group?s John Ameriks, who argues in this blog post that, after a decade-long rally, the metal appears grossly overvalued for every economic scenario except perhaps complete collapse.

Matt Zeman, a trader at LaSalle Futures Group in Chicago, says gold bulls can at least make the case that the metal continues to see plenty of patient buyers emerge whenever the price pulls back, as it did last month.

?They all want to buy it on sale,? Zeman said.

By contrast, at the height of market bubbles -- think housing -- the get-me-in-at-any-price mentality usually takes over.

-- Tom Petruno

Photo: A 2,200-year-old Egyptian gold coin. Credit: Israeli Antiquities Authority / European Pressphoto Agency