Gold's Appeal, Even in Deflationary Times

By Eric Jackson
RealMoney Contributor
6/7/2010 5:00 PM EDT
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Last week, I met up with Eric Sprott, a hedge-fund manager who has been a pronounced gold bull and market bear since the 2000 Nasdaq bubble burst. I will post a full interview with him later this week inTheStreet. In the meantime, I want to lay out some of his arguments concerning gold for you to consider.

Gold is seen by some investors as a useless yellow rock. You can't eat it, this line of thinking goes. It was something that people clung to centuries ago, but it has no use today -- especially when there are so many compelling stocks to invest in. Besides, the thinking also goes, if you want safety, you can buy U.S. Treasuries. People who pooh-pooh gold also tend to characterize the gold bulls as kooky, end-of-the-world types.

It was anti-gold thinking like this that drove down the price of gold 10 years ago to $250 per ounce. That drop in the price of the metal also coincided with the ultra-high-risk appetite that investors had at the time for tech stocks.

Many non-followers of gold assume that what drives the value of the metal is inflation. But we've seen the value of gold quintuple over the last decade in a period of deflation -- not inflation. And many are of the view that deflation will be with us for the foreseeable future.

Sprott's view of gold is that the metal is -- and will be -- driven by two fundamental factors: (1) limited supply of the metal and (2) a view that the metal will become increasingly seen as a safe and alternative currency vs. other fiat currencies.

On the first factor, physical scarcity, you might not realize that there are only 162,000 tons of gold in the world today. And all the miners of the world are only extracting another 2,500 tons annually. If suddenly all central banks and investors decided that they wanted to allocate 5% of their portfolio to gold, there would not be enough to go around.

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