GOLD, A BET AGAINST REALITY:

Gold is a bubble - resist its charms (Janice Revell, January 10, 2011, CNN Money)

Gold has traditionally been considered a hedge against high inflation. And gold bulls argue that the money the Federal Reserve has been pumping into the economy will eventually create runaway consumer prices, as more dollars chase too few goods.

Gold, the thinking goes, will hold its purchasing power -- after all, it can't be manufactured at the whim of a central bank. Gold enthusiasts point to a strong precedent for its vigor: During the late 1970s and early '80s, when the inflation rate surged by double digits, gold prices also soared, rewarding investors handsomely.

Right now, though, there's no sign that inflation is about to rear up anytime soon. For all the Fed's efforts to inject money into the system, the folks who have it -- banks, mostly -- have been reluctant to do much besides sit on it, leaving too few dollars chasing too many goods.

As a result, the inflation rate stands at just 1.2%, down sharply from 2.7% in December 2009. In fact, the bond market has been signaling fears of low inflation or even deflation -- a sustained weakness in prices that could hold down the economy for years. The yield on the 10-year Treasury bond is about 3%. Bond investors wouldn't accept such paltry yields if they saw high inflation.

Maybe bond investors are just wrong, and the gold traders are right. Or perhaps, says HSBC commodities analyst James Steel, investors are hedging their risks by buying bonds as a defense against the short-term threat of deflation, and gold as a store of value "in case inflation eventually takes off."

That's plausible. But the case for gold depends a lot on what you think "takes off" means. Many market observers do believe that inflation is going to rise eventually. The Fed seems to be trying to engineer at least a modest increase, and there's hardly anywhere to go but up from here.

However, a return to 3% inflation or even something a bit higher isn't what many gold investors are betting on. Many are concerned about low-probability catastrophes like the collapse of the global money system or a U.S. debt default. It's not that those things are impossible -- it's that gold owners have to worry about what happens to their investment if those things don't happen.

"Gold is already fully pricing in some very nasty scenarios, including high inflation," says Jason Hsu, chief investment officer at Research Affiliates. "The price is going to react in a very negative way to any reality that deviates from that expectation."

That reality would include a continuation of the sluggish, unemployment-ridden, but modestly growing economy we seem to be stuck in now.

And if the economy turns back to real health, watch out. From 1980 through 2005, gold earned zilch. In fact, if you had bought gold at its peak in 1980, you still wouldn't be back to even today on an inflation-adjusted basis.

"When the economy moves from recession to prosperity, there will be little reason to own gold," says Mark Williams, who teaches risk management at Boston University. "And speculators will learn the hard way that gold in times of financial stability is hazardous to investor health."