A Look Back On Gold

By Sham Gad | December 28, 2009 AAA

What a year it has been for gold! For most of the year, the price of gold hovered between $850 and $950 per troy ounce, with big bets on the shiny yellow metal being made by hedge fund gurus John Paulson and David Einhorn. Despite their convictions for betting on gold, the metal has been shunned by many investors.

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Don't Be So Quick To Judge
From a fundamental perspective, the story on the disadvantages of investing in gold has been easy to make. Gold has no earnings, so there is no way to fundamentally value it compared to stocks. Gold does not typically get destroyed through consumption, so it doesn't get used up like oil, gas and other commodities. Although these are clearly valid arguments, they ignore some of the significant characteristics of gold.

To really understand the valuation of gold, knowledge of history is required. Those with time to read over the holidays ought to take a look at "The Power of Gold" by the late Peter Bernstein. The book offers an excellent historical account of gold's importance to societies going back hundreds of years. And therein lies the secret to understanding gold. It has been considered a store of value way before stock markets existed and our modern financial formulas were created. Societies all over the world defined gold as the store of value, no matter what, as gold could be counted on when nothing else could. Up until the 1970's, the US was on a gold standard, which meant each dollar represented a specified amount of gold reserves. (Learn more about the gold standard at The Gold Standard Revisited.)

The World Today
Gold has held up during periods of uncertainty and inflation. Indeed, owning stock in strong, quality commodity businesses is a good bet to make during inflationary periods. Today, central banks all over the world are stimulating the economy with record amounts of new money, all but guaranteeing inflation sometime in the future. But it's not only inflation that worries gold bulls. The monetary easing occurring today is unprecedented and generates increased uncertainty about how liquidity will be dealt with. Central banks really have no idea.

Beginning in the fall of 2009, the price of gold leapt from $900 an ounce to over $1,200 heading into December. This bubble-like surge resulted from a combination of increased uncertainty, India's $6 billion purchase of gold from the IMF as well as a little speculation from investors. The SPDRS Gold Trust (NYSE:GLD), an ETF that buys physical gold, was up over 20% in the three months leading into December. However, shares in gold miners like Barrick Gold (NYSE: ABX), AngloGold Ashanti (NYSE:AU) and Kinross Gold (NYSE:KGC) haven't fared as well because of their need to buy out hedge contracts that obliged them to sell gold at much lower prices. If gold continues to head north, eliminating the hedges will lead to a drastic surge in profits for the gold miners.

Bottom Line
Buying gold is a bet on inflation, but more specific to today, it is a bet against current monetary systems. Since today's money is fiat - backed by the credit of issuing governments - it is not difficult to see why gold is beginning to shine in the eyes of many. Imitating the Chinese, next year may be the "year of the gold bug." (Learn more about investing in gold at The Midas Touch For Gold Investors.)

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