Those facts hardly seem to matter in tranquil times. Rather, most traders typically scorn investing in the yellow metal because they view it as dead money. And that remains the case here in mid-2008, despite a near tripling of gold prices over the past several years.

Source: Bloomberg

In fairness, gold has been pretty much dead money for long stretches of time, since then-President Richard Nixon took the US off the gold standard and allowed its dollar price to float freely in 1971. And the last such period was relatively recent, running from gold’s peak above $800 an ounce in 1980 to its ultimate nadir earlier this decade at less than $300 an ounce.

Although investors’ consensus perception of gold hasn’t changed much from earlier this decade, gold’s fundamentals definitely have. The US dollar’s weakness against other currencies since it 2001 peak is often credited–or blamed–for most of gold’s gains.

Money has flowed to the yellow metal as a hedge, as sentiment against the greenback has grown. Following the logic, once the US dollar gets back on track, gold will crash back down to its former levels.

The dollar’s moves do have an impact on gold prices. And the greenback’s mild recovery over the past few months has taken a toll, bringing the metal back in the $900-an-ounce area from this year’s high point of more than $1,000. But the buck is far from the only bull market catalyst here.

For one thing, there’s politics, mainly the growing turmoil in many areas of the world, particularly the Middle East. It’s not our business to speculate on upcoming events, but there are plenty of potential bolts from the blue that could create chaos and send gold much higher.

To date, Americans have never had to experience the society-wrenching events that have affected much of the world for centuries. But most of the globe’s population hasn’t forgotten the value of gold in times of extreme strife and social turmoil. And with incomes rising in many of these countries, beneficiaries have used their newfound savings to beef up their holdings. That’s a trend with serious legs, particularly as Asia continues to grow.

Then there’s inflation, the ultimate debaser of all paper currencies. Despite surging energy and food prices, core inflation remains at elevated–but still relatively moderate–levels in most of the developed world. Developing world inflation, however, is a far different story. And many countries have seen sharp price acceleration across the board, including China.

The Chinese government’s preferred method of fighting inflation has been to push for the consolidation of less efficient industries, including electricity-intensive aluminum. Export subsidies have been slashed and power prices have been raised to better reflect market forces. Nonetheless, inflation pressures overall are a growing concern.

In the developed world, central banks are at least starting to pay lip service to inflation pressures. The US Federal Reserve has made a major show of late, halting its recent string of interest rate cuts. Canada surprised many this month, keeping its benchmark rates static. And the European Union has threatened rate hikes as well.

The critical point is there are limits placed upon how much bankers can change during extreme weakness in the US banking system and weakening economic growth in both the US and Europe. So far, the slowdown has been relatively mild by historical standards. But truly aggressive action to curtail inflation could tip the balance into a deep recession, pushing up the cost of currencies dramatically as the prices of basics–such as food and energy–soar on often subsidized demand overseas.

Again, trying to figure out what central bankers are going to do in advance is not what we’re about. But given the extreme risks of igniting a major recession, it seems like the Fed and its counterparts have little choice but to continue to live with at least creeping inflation.

As long as that’s the case, currencies will debase, and the stage will be set for a renewed surge in gold in the coming months. And if they do act dramatically and the worst occurs, the yellow metal is nearly certain to go higher still amid the economic chaos that ensues.

Gold’s greatest selling point is that it’s still well off its highs in inflation-adjusted terms. By that standard, setting a new high would imply a move to at least $3,000 an ounce. As we’ve said here before, that’s not a prediction. But it is a pretty good indication that this market can run a lot further.

Patience is the biggest challenge when it comes to cashing in on what’s likely to come for gold. As we wrote with the first issue of VRI last October, we have no perma convictions. Rather, we’re interested primarily in what’s working now. We’re also not averse to taking profits in the near term, even in the context of a larger bull market. And we’re willing to sell out of positions that don’t pan out as we expected.

The difference with gold is–despite the gyrations in price–we’ve been making money in the three positions we’ve recommended so far. Big miner Goldcorp (NYSE: GG) is up by more than a third from our October 2007 recommendation.

Small, more leveraged player Lihir Gold (Australia: LGL, NSDQ: LIHR) is roughly flat. As we’ve pointed out, however, it’s working its way through its internal challenges, pointing the way to big gains on gold’s next lunge forward. And our streetTRACKS Gold Trust (NYSE: GLD) position–an exchange traded fund that represents a position in gold bullion–is up by more than 20 percent.

In other words, gold positions are working. How much they’re working changes literally from day to day, even minute by minute. This is a huge, volatile market traded on a global scale, and it’s affected by myriad pressures over both the long and short term. Playing it right means being willing to take these moves in stride.

As we previously pointed out, the biggest near-term risk to our profits now is the possibility of further strength in the US dollar in coming weeks. (See VRI, 8 May 2008, The Destructive Dollar). The key is that the potential reward from gold’s next leg up is well worth the risk.

The bottom line: If you’ve bought into our gold positions already, our advice is to hold on. If you haven’t yet, now’s a good time to pick some up.

To review, the most conservative play is streetTRACKS Gold Trust, which we continue to rate a buy at the current market price. Next is Goldcorp, a large and growing producer that still rates a buy up to 45. Finally, our leveraged bet and turnaround story is Lihir Gold, a buy up to 40 for those who can handle the volatility.

On Steel and Its Raw Materials

A few days ago, Rio Tinto (NYSE: RTP) settled with China’s Baosteel on iron ore prices. Lump iron prices increased by 96.5 percent to USD126 per ton, while fine iron (i.e., powder) increased by 80 percent to USD91 per ton. Both increases were higher than that of Companhia Vale do Rio Doce (NYSE: RIO, CVRD), which settled for a 65 to 71 percent increase in November. Notice that fine iron accounts for more than a half of all iron ore, while lump ore represents around 30 percent.

The higher settlement is significant because it allows Australian producers to cover some of the shipping differentials that exist between Australia and China (USD31 per ton) and Brazil and China (USD55 per ton) because of the former’s proximity to China. Now the differential should be around USD15 per ton, still in favor of the Brazilian route. See VRI, 4 October 2007, The Definite Bull.

Although China has about 80 million tons of iron ore stockpiled in its ports, the government has been making every effort to remove it because demand remains strong. The process is taking some time, and imports may slow a bit in the next couple months, but tight supplies and strong demand will support iron ore prices in the short-term before the next substantial move higher. Both Rio Tinto and CVRD remain buys.

South Korean steel producer Posco (NYSE: PKX) also announced that it will be raising prices starting July 1 by an average of 20 percent. That’s the third price hike this year.

Although Posco has been challenged by the continuous rise in raw materials, it’s been able to continue raising its prices because of the strong demand for steel, which we expect to remain. As a result, we’re more worried about the weaker Korean won rather than pricing because Posco imports its raw materials. But, overall, we expect the price hikes will cover the costs. Posco remains a buy at current prices.

Finally, portfolio holding Xstrata (OTC: XSRAF) is expected to raise coking coal prices by 20 percent to USD360 per ton. Xstrata remains a buy.

Speaking Engagements

Be sure to wear a flower in your hair when you venture west to San Francisco. My colleagues Neil George, Elliott Gue and I will be heading to “The City” Aug. 7-10, 2008, for the San Francisco Money Show.

We’ll discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.

Click here or call 800-970-4355 and refer to priority code 011362 to attend as our guest.

Also, be sure to check out our blog, At These Levels, for more noteworthy stories.

Special Invitation

We have a special invitation for our readers. KCI Communications, Inc., publisher of Vital Resource Investor, is organizing an exciting 11-day investment cruise Dec. 1-12 through the Caribbean and Panama Canal. Participants will have the opportunity to meet and chat with my colleagues Elliott Gue, Gregg Early and Neil George and myself.

This will be a unique opportunity to step away from your daily routines, relax in one of the most beautiful parts of the world and share analysts’ knowledge and passion for the markets. During the sail, you’ll not only explore the cerulean splendor of the Caribbean, but you’ll also delve deep into current markets in search of the most profitable opportunities for your portfolios. You’ll also have the rare chance to sail through one of the world’s engineering marvels, the Panama Canal.

It’s always a special treat to meet and talk with subscribers in person, and we couldn’t have picked a better setting than aboard the six-star Crystal Serenity. This is sure to be an especially memorable experience. We hope you’ll join us.

For more information, please click here or call 800-832-2330.