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Markets: Gold: The King of Commodities?
New York: May 09, 2005
By John R. Stephenson

For some, there is no commodity with quite the luster of gold. Throughout history, it has functioned as a currency, and proven to be an effective hedge against inflation. It is a commodity that has been prized by the ancients for its rarity and durability. No other asset has quite the mystique and popular appeal of gold. It has always been this way. Those who believe in the power of gold -really believe. Gold is king and no other commodity comes close. But is all this attention warranted?

Gold has held a special place throughout the ages. The Romans issued the first gold coins in 50 B.C. and the Incas used gold in just about every artifact they created. Its beauty and rarity have made it a prized possession. Today, the true believers are called Goldbugs. They believe that gold and gold alone is the only true currency providing an effective hedge against a wide range of economic calamities - from stock or real estate meltdowns to a collapse in the U.S. dollar. With so much to worry about, Goldbugs reason that an explosion in the price of gold is just around the corner.

Goldbugs 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, Goldbugs should have discovered that many other commodities such as cattle and pretty beads have been used throughout history as the ultimate money . While there is no doubt that gold has had its day in the sun and that it may very well again, the fuss over gold just doesn't add up.

During the late 1960's, gold traded as low as $35 an ounce only to soar to an historic high of $850 an ounce in 1980. But, for decades, the price of gold has gone nowhere. And while commodity prices have been soaring and the U.S. dollar has been swooning, gold has hardly had the kind of rally that other commodities have enjoyed. The reason? The supply and demand fundamentals for gold just aren't that great.

Figure 1: Annual Gold Prices

Source: CRB Yearbook

While the supply of most commodities has been allowed to dwindle over the last twenty years, the supply of gold has continued to grow. Even when the price of gold was in the tank, gold production continued to accelerate. In 2003, with a commodity bull market underway, some three-quarters of the mining exploration worldwide was for gold. Yet other commodities held far greater promise. It is almost as if the mining executives are as enamored with gold as the general public. Today, gold inventories are the highest they have ever been in the history of the world. Not only that, but unlike any other commodity, gold is virtually indestructible and is still out there kicking around in one form or another.

According to Gold Fields Mineral Services, the "aboveground stocks" of gold in 2003 totaled some 150,500 tons or roughly 61 percent of all the gold that has been mined since 1950. 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). But all the gold in Fort Knox is insignificant when compared with a $600 billion current account deficit (exports minus imports) and the $350 billion budget deficit that the U.S. is running - further underscoring the diminished role that gold plays today in backing paper currencies.

Other than as a psychological backstop for paper currencies, just what are the uses for gold? While gold still serves as an important fixture in jewelry, especially in countries such as India where it is given as a dowry and in the Middle East where it is used to flaunt one's wealth. But throughout the west and particularly in the U.S., gold jewelry has lost some of its luster. Today, the real use for gold is primarily in industry (televisions, computers and rocket engines) where its malleability and corrosion resistance are prized qualities. As well, gold is also used in dentistry and in medical applications. But despite these uses, primary gold demand has been falling over the 1999-2003 period with gold demanded by industrial and other uses down some 17,300 tons and gold jewelry demand down 76,800 tons.

The last few years have seen a surge in the price of gold. This seems at odds with strong supply and weakening demand trends. As has always been the case, there is a certain mystique with gold which always serves to draw out a speculative element in the gold market. With concerns running high that the U.S. government debts will lead to a collapse of the currency, speculators have come out of the woodwork to drive up the price of gold. While I believe that the U.S. dollar will likely fall in the years to come and gold will benefit as a result, it will be the forces of supply and demand and not wishful thinking that will drive the price of gold as they have every other commodity throughout history.

For investors looking to profit from a likely tumble in the U.S. dollar, a small portion of your portfolio invested in gold can make some sense. The simplest way to invest in gold without all the hassle and bother of trying to find a decent gold producer with a clean balance sheet and capable management is to consider investing in the Streettracks Gold Trust ("GLD" NYSE) an ishare which tracks the price of gold and gives you the exposure to the commodity you want while at the same time offering you the convenience and liquidity of a stock.

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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