Historically, fighting inflation has been the primary focus of  the Federal Reserve. Its main weapon in the battle against rising prices is the ability to control the flow of money. The Fed has at times been so aggressive in its actions against inflation that it has actually driven the economy into recession by tightening the money supply too much.

So when the Fed cut interest rates by half a percent, that surprised many Fed watchers, who were expecting a less aggressive quarter-percent cut. Don’t forget that the Fed had already unexpectedly cut the discount rate by a half percent. 

Does that mean Fed officials believe inflation is under control? Not necessarily. The same statement that announced the Sept. 18 rate cut said this about inflation: “Readings on core inflation have improved modestly this year.  However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.”  In fact, there are quite a few experts who believe that inflation remains a significant threat.

One of the traditional means of measuring the potential for inflation is the price of gold. Right now, the price of gold is nearing its all-time high.

On the chart below, the gold line is the price of gold, while the black line is the Nasdaq for comparison. The price of gold spiked and peaked in May of 2006. Since then is has mostly drifted sideways. But there has been a renewed surge over the past few weeks.

Here are some comments about the price of gold from U.S. Rep. Ron Paul (R-Texas) made before Congress in April 2006: 

“Buying gold and holding it is somewhat analogous to converting one’s savings into one hundred dollar bills and hiding them under the mattress – yet not exactly the same. Both gold and dollars are considered money, and holding money does not qualify as an investment. There’s a big difference between the two however, since by holding paper money one loses purchasing power. The purchasing power of commodity money, e.g., gold, however, goes up if the government devalues the circulating fiat currency.

“Holding gold is protection or insurance against government’s proclivity to debase its currency. The purchasing power of gold goes up not because it’s a so-called good investment; it goes up in value only because the paper currency goes down in value. In our current situation, that means the dollar.” 

Of course there are also experts who believe that the price of gold is not a good indicator of the likelihood of inflation. I could fill this paper with arguments for both sides. Right now the only important factor is that the price of gold is going up and that could mean higher inflation will follow. But that doesn’t mean you should go out and buy gold. Under the best of circumstances gold can only be considered as a speculative investment.

Have a great weekend.

F.S.
If you would like an investment strategy that attempts to minimize risk but still provides the opportunity for solid growth, check out the Foundation Strategy from Strategis Financial Group.  This actively managed strategy is designed to take advantage of the experience and expertise of some of the nation’s best mutual fund managers. To learn more, call me, Flint, at 800-279-3377.

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