George Soros is a world-renowned former billionaire hedge-fund manager and philanthropist. He co-founded the Quantum Fund in the 1970s with Jim Rogers, another world-famous investor. Soros’ fame grew in 1992 when he made $1 billion by short-selling the pound sterling, speculating that the British government would be forced to devalue the currency. He became known as “The Man Who Broke the Bank of England.”

Unlike his former partner Jim Rogers, who is credited with anticipating the commodity boom that started in the late 1990s and who is keeping his gold, Soros has been selling a lot of gold. The moves speak volumes. He believes gold is in a bubble and he’d rather sell before everybody else catches on.

#-ad_banner-#In September of 2010 Soros said “Gold is the ultimate bubble, it is certainly not safe.” In the first quarter of 2011, he sold nearly $800 million worth of gold exchange-traded funds (ETFs) and stocks. After that sale, his company, Soros Fund Management, owned less than 50,000 shares of the SPDR Gold Trust (NYSE: GLD), down from a reported 4.7 million shares. He also reportedly sold 5 million shares of iShares Gold Trust (NYSE: IAU).

Soros was reported to have had just under $1 billion in gold ETFs and related stocks at the end of December, 2010. After these sales, the value of his gold holdings was reduced to a little more than $200 million.

Unfortunately for Soros, I think he’s wrong. Gold is not in a bubble. And there are several factors pointing to even higher prices.

Gold did pull back a bit after Mr. Soros announced his sale. The GLD ETF fell from an intraday high on April 29 of $153.03 to an intraday low of $142.55 on May 5, a 6.8% fall. A temporary correction from current levels is always a possibility, but the price is flying high once again, recently trading above $150. And it seems poised to move higher.

Here are five reasons why…

1.  QE2 ending is not the end
Recently released economic data point to a slowing U.S. economy. The housing market is double-dipping as prices in some areas of the country are as low as they were in the early 2000s. Unemployment is up to 9.1%. Consumer sentiment is down. And China, our critically-important trading partner, has also seen its economy slow. On June 7, Federal Reserve Chairman Ben Bernanke publicly admitted the U.S. economy is slowing.

Given these factors, the end of QE2 (Quantitative Easing II) — the Fed‘s practice of buying U.S. treasuries to add liquidity to the credit markets — may not really be at hand. With no other viable options to stimulate the economy, it will likely keep the liquidity flowing, whether it’s called QE3 or not. Maintaining current liquidity levels or adding more will likely weigh on the dollar and support gold.

2.  Inflation is low (but higher than you think)
While the government wants some inflation, it also needs to prevent it from getting out of control. Governments typically increase the money supply  when the economy has stalled or is in recession, making it less expensive to borrow, hoping to stimulate growth (and therefore creating inflation). The targeted inflation rate of 2% represents an idealized level of growth for the economy.

The consumer price index (CPI) is a statistic that measures the price of consumer goods and services and is the measure upon which monetary policy is based. A popular complaint is that the government focuses on “Core” CPI, the version that ignores food and energy, two critical components to a consumer’s economic well-being.

Core CPI is low, up 1.3% year-over-year. “Headline” inflation, the CPI with food and energy included, is actually much higher, currently near 6%. Under normal circumstances, higher inflation would motivate the Fed to raise interest rates from the historically low 0% that has been held since December 2008. But with core CPI at an acceptable level and with the economy slowing, investors should not expect that to happen anytime soon. Continued low interest rates will likely be maintained despite the risk of higher inflation in the hope of further stimulating the economy. Low rates should translate into more economic activity and demand, driving commodity prices, including gold, higher.

3.  Gold ownership by individual investors is not higher than normal
Asset bubbles are characterized not just by rapidly-escalating prices but also by abnormal participation of individual investors. During the tech bubble of the late 1990s, one would frequently hear about mailmen, landscapers, barbers and others one would not normally expect to be talking about the stock market making tech stock recommendations. That was an indication of a larger-than-normal level of participation and a bubble brewing.

Today, despite the media coverage, the actual rate of gold ownership by individual investors is at or below historical norms (see table below). If gold were in a bubble, people wouldn’t just be talking about it, they’d be buying it en masse. Until gold ownership increases dramatically, I’d take lightly claims of a bubble that’s about to burst.

 

4.  The U.S. dollar will continue to decline
Unfortunately for Americans and anyone who owns U.S. dollars, the decline in the dollar is likely to continue. The enormous debt and entitlement obligations of the United States coupled with the slowing economy suggest the government will maintain its weak dollar strategy. Until the economy stabilizes and the government seriously addresses its financial obligations, expect the dollar to continue to decline. A weaker dollar means higher gold prices. [See David Sterman’s “Why Politicians in Washington Could Cause a Global Financial Crisis”]

5.  The fear factor
The mention of replacing the U.S. dollar as the world’s reserve currency was met with laughter only a couple of years ago. American dominance was considered absolute and eternal. No longer.

The United States is dependant on foreign investment to fund its debt. China, the biggest buyer of U.S. treasuries, has become more and more vocal about how the United States is handling its financial travails. China can frequently be heard criticizing the U.S.’s decisions and talking overtly about replacing the dollar. And China is not alone. One idea gaining traction is to replace the dollar with a basket of currencies. Even a partial replacement of the dollar would significantly reduce demand, sending its value plummeting and gold prices higher.

Action to Take –> Don’t sell your gold. If you’re worried that the bubble-talk might be true, then sell some — but not all. Gold has performed very well in the last decade, but its price ascension has not been at an unreasonable pace. And while George Soros has made some good market calls in the past, I think he’s wrong on this one. Sometimes asset prices rise for very good reasons. This is likely to prove to be one of those times.

P.S. — We found an obscure mining company that tossed back 19% in dividends last year (plus another 34% in capital gains). If you think that’s impressive, wait until you see this video…