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Markets: Gold: It's Back!
New York: December 12, 2005
By John R. Stephenson

Something old is new again. In case you haven't noticed, gold is making a comeback. While oil is still the dominant story of the year, gold is on a tear and has started to get heads-a-wagging about the resurgence of this precious metal. This past week, gold hit U.S. $530.20 an ounce. Not only that, but last week gold futures (contracts for future delivery) hit a 24-year high and their best week since 2002. Without doubt, gold, at least for now, is back!

With a sustained move above $500 an ounce, gold bugs and others are talking. Gold has come a long way in a short period of time. It wasn't so long ago, 2001 to be exact, that gold tested the $250 level. Gold, more than any other commodity, is volatile with much of its price movement being driven more by sentiment than by fundamentals (supply and demand).

If you talk to gold bugs, they will tell you that the world is coming to an end. They will tell you that the U.S. dollar is poised for a pratt fall and that gold, unlike anything else, is uniquely positioned to capture that movement. According to the converted, that's because gold, unlike oil or natural gas, was once a currency.

Gold bugs love to point out that gold was once used as a reserve currency for the world and that central banks around the world hold some 1 billion troy ounces of gold (approximately US $400 billion) as a psychological backing for their paper currencies. But even with a modest amount of research, gold bugs should have discovered that many other commodities such as cattle and pretty beads have been used throughout history as the ultimate money.

But for all the hype, gold as an investment is questionable. Back in 1934, gold was valued at $35 an ounce and the stock market (S&P 500) was clocking in at 9.8. Fast forward to today and gold at over $500 an ounce is up 15 times since 1934 — but the stock market is up 120 times.

Old habits die hard, and with inflation on the march and the U.S. dollar likely to slide against other major currencies, gold is back. In a world filled with problems, gold, with its legacy as a currency and its appeal as something real, is in vogue. For true believers, only gold can maintain its value. Paper currencies are just too susceptible to manipulation and devaluation by governments. A dollar today is only worth about 5 cents of what it was worth in 1900, but gold still buys the same amount of "stuff" as it did back then. Gold holds its value.

Around the globe problems abound. The economies of Europe are barely in drive with far too much deadlock and not enough reform. Japan, while better on reform, is stuck with an aging demographic and not much growth. How slow is the growth in Japan? Slow, with yields on the 10-year Japanese government bond clocking in at a mere 1.5% yield. In the United States, massive consumer spending and government borrowing has left a mountain of debt for the U.S. dollar to navigate.

Massive government and personal debts, coupled with a negative personal savings rate, are the order of the day in the U.S. The problem? As a nation, we are spending more than we are making, with foreigners bridging the gap and extending us the credit to keep on spending. So what's the problem with this arrangement? Lots. As Morgan Stanley's chief economist Stephen Roach writes: "The day will come when foreign investors simply say 'no' to this arrangement - refusing to fund America's consumption binge without getting a meaningful concession on the terms of the financing. That's when the dollar collapses, U.S. interest rates soar, and the stock market plunges".

With concern on the rise that the world's major economic powers may not be able to honor their IOUs, gold is on the rise once again. But this time, there is something else at play. Strong fundamentals.

Strong demand for gold jewelry through a resurgent Asia is part of the reason. Overall demand for jewelry has risen by $38 billion in the past year, in large part due to the strong demand from India — home to one-quarter of the world's jewelry. In India, gold is an important fixture in jewelry and is often given as a dowry. With Asian countries showing strong economic growth (7 percent a year), gold, a status symbol in that part of the world, is in demand.

But demand from Asia and the sorry state of major world economies is not the only reason that gold is hot. Rumors abound that central banks in far-flung spots such as South Africa, Argentina and Russia are looking to increase their gold reserves. Central banks around the world have stockpiled gold as a psychological backstop for their paper currencies. The U.S. holds the most gold in Fort Knox at some 262 million troy ounces ($100 billion market value) followed by Germany (112 million troy ounces) and France (97 million troy ounces).

So with gold hot and likely to get hotter, is it time to jump in? Probably. But gold should form an important part of your investment portfolio in any event. Not because it's the best investment going, but rather because gold is a form of insurance. Will we see gold at $1,000 an ounce or higher? Probably, but along the way gold will lurch lower and then higher as reports about jewelry demand, central bank buying and U.S. dollar weakness hit the markets.

Gold is the real thing. No matter what happens, one thing that is certain is some calamity will beset the world. When that happens, gold and the stocks of gold producers will soar. When that will happen is anyone's guess. In the meantime, a couple of gold bars stuffed in a safety deposit bank will be a form of insurance and only that. While many may speculate, true investors diversify, hold insurance and relax.

As a trade, gold tends to peak in late winter and trough in late summer as much of the demand for gold jewelry occurs around the holidays. Gold companies make good sense when gold prices are surging because of the strong leverage that company earnings have to the increasing value of gold.

But for investors who don't feel like storing gold, analyzing company financial statements or trading the commodity, a safe and easy route is to hold an exchange traded fund (ETF). ETFs offer all the advantages of a stock or mutual fund without all the hassles. In Canada, the gold ETF is the XGD and in the United States the gold ETF is GLD. The XGD, for example, gives you a beneficial ownership in the 17 component gold companies that make up the S&P/TSX Capped Gold Index. In an uncertain world, doesn't it make sense to hold a little gold?

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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