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Going for Gold
New York: September 27, 2010
By John Stephenson

Commodities are hot and getting hotter, but none is more incendiary than gold—the only commodity to be making record highs recently. The reasons that investors are piling into gold are many: stocks and bonds look increasingly shaky in these uncertain economic times, gold supply is slumping and the U.S. dollar is falling against the Euro. Behind the rally into gold is the fear that central banks, such as the U.S. Federal Reserve Board, will resort to printing boatloads of money in an effort to jump-start the American economy.

Commodities are hot and getting hotter, but none is more incendiary than gold—the only commodity to be making record highs recently. The reasons that investors are piling into gold are many: stocks and bonds look increasingly shaky in these uncertain economic times, gold supply is slumping and the U.S. dollar is falling against the Euro. Behind the rally into gold is the fear that central banks, such as the U.S. Federal Reserve Board, will resort to printing boatloads of money in an effort to jump-start the American economy.

Gold prices are up more than five-fold over the last decade as worries over the health of the global economy have given the metal a fresh lift. Last Tuesday, gold got another fresh boost as the U.S. Federal Reserve stated that they are “prepared to provide additional accommodation” to support the economic recovery. On the news, the U.S. dollar tumbled by three percent against the euro this past week. This announcement was broadly interpreted by the market as a clear signal that the U.S. Fed would print money and commence an aggressive program of bond-buying in the near future.

For fans of the metal, gold has further to run. While the recent run to nearly $1,300 per ounce has been impressive, it’s still a long way off from its 1980 inflation-adjusted high of $2,300 per ounce. Back then, gold surged and investors clamoured to buy physical gold from major bullion dealers. None of that froth is apparent in this latest surge in price, suggesting that for now, gold’s move higher has been driven entirely by institutions with little help from retail investors.

Unlike paper money, gold supply is finite, making scarcity one the big benefits of owning gold. Estimates have pegged the amount of gold above ground at around 165,000 metric tons, with some 20,000 metric tons still waiting to be mined. Nearly 90 percent of the known gold in the world, with a rough value of $4.5 trillion, has already been mined. That’s a big number, yet it pales in comparison to the more than $8 trillion U.S. dollars in circulation and a world stock market capitalization of roughly $40 trillion. And stack gold up against the outstanding notional value of the world’s derivatives market—a whopping $800 trillion—and the value of physical gold looks puny. In fact, the ratio of physical gold to paper currency is at an all-time low, which suggests that the stage is set for a powerful rally.

Gold appears to returning to its historic role as an asset of choice for large investors and to buttress the foreign exchange reserves of central banks around the world. Because it is the one financial asset that cannot be printed, its value is on the rise as central bankers and investors clamour to get their hands on greater quantities of the metal. In the last few months, India, Thailand, Sri Lanka and Bangladesh have all announced that they are buying up gold. China, has been selling some of its massive U.S. dollar holdings and in its place lapping up Japanese yen in an effort to diversify away from the dollar.

Ever since the Carter administration, the U.S. government has been shortening the duration of the national debt. Investors are fretting that a huge amount of U.S. treasuries will have to be rolled over in the next few years at the same time when competition from the private sector is likely to peak. The prospect of re-financing a significant portion of the national debt at rock-bottom interest rates looks increasingly unlikely. Sharply higher rates could derail the economic recovery and send gold on its next leg higher.

To date, most of the buying in gold has gone into exchange traded funds (ETFs) with modest buying from central banks. The shares of gold mining companies have failed to keep pace with the surge in the metal suggesting that there may be an opportunity for the gold miners to play catch up.

While gold prices have moved up sharply, they still don’t represent a huge part of most investment portfolios, suggesting that gold has further to run. And while gold looks expensive, in relative terms it’s still cheap compared with its inflation-adjusted peak. For gold to move higher and stay higher, investor attitudes toward the metal will need to change. Rather than being viewed as a barbarous relic, gold is beginning to reassert itself as the world’s fourth currency after the U.S. dollar, euro and yen.

With the International Monetary Fund (IMF) being called upon to bail out Greece and others of the world’s so-called wealthiest economies, there seems to be no shortage of highly indebted nations to be restructured. This uncertainty and sluggish global growth should make stock markets far more volatile and further support the rally into gold. At the very least, investors should consider adding gold to their portfolios as a hedge against further fallout from the financial follies of free-spending governments.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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