As a value investor, I have never seriously viewed gold as a viable long-term investment. After all, once it's mined, it sits there either in bars or in jewelry. Unlike oil, the quantity of gold doesn't deplete regularly over time. However, there is an important lesson to be learned over the years, one that stems from Charlie Munger's wisdom to "invert, always invert." (For more, see Warren Buffett: The Road To Riches.)
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Full Faith and Credit in Gold
The U.S. dollar is a fiat currency, meaning that it is backed by the full faith and credit of the United States. While the U.S. still remains the most credit-worthy nation on Earth, its credit worthiness is being put to a test.
The proof is in the pudding. At the beginning of 2009, the yield on the 10-year Treasury note was approximately 2.4%; today, just six months later, the yield is just about 4%.
A nearly 160 basis point move in just six months is huge in the Treasury market. It means that the U.S. Treasury has to sweeten their terms to continue to stimulate demand for U.S. securities.
Treasury buyers, mainly China, need to be induced to continue buying U.S. debt - an implication that Treasuries may be losing a little luster. As the U.S. continues to print more and more money to stimulate the economy, this trend is likely to continue. (To learn more, check out our Inflation Tutorial.)
Expanding Balance Sheets
It's not only the U.S., but balance sheets of central banks all over the world are growing at a rapid pace as countries attempt to spend their way out of this global recession. Inflation can be defined as simply too much money and not necessarily too much money chasing few goods.
There are plenty of goods in this world. But money supplies are increasing at a rapid clip and at some point such expansion will have an inflationary effect. Don't count on inflation anytime soon; the world still has lots of deleveraging to work out. However, inflation is but one catalyst that will stimulate the demand for gold. A deteriorating loss in confidence in central banks is also a very serious threat.
Follow the Smart Money
Some serious hedge funds are betting on gold. John Paulson, who made a fortune betting against mortgages back in 2006, is making a big directional bet on gold. He is known for showing up early and profiting handsomely. According to an SEC filing, Paulson has nearly $3 billion of his $9 billion hedge fund, invested in the SPDR Gold Trust (NYSE: GLD), an ETF that simply owns physical gold.
Another $100 million is in South African gold miner Anglogold Ashanti (NYSE: AU). Another $550 million is in Kinross Gold (NYSE: KGC) and $200 million is devoted to Gold Fields (NYSE: GFI).
In all, Paulson has nearly $4 billion invested in gold. That is a huge directional bet on one thing: that the gold price will be much higher years from now. And I don't think he is betting on gold just getting to $1000 an ounce either. Investors can easily diversify into gold by looking at the Market Vectors Gold Miners ETF (NYSE: GDX).
The Bottom Line
In a market littered with many uncertainties, gold shines as a safe haven. The entire global economy is suffering from an unprecedented global credit crisis. Another small hiccup could send gold soaring. A chance to protect your portfolio from this serious threat should be investigated. (For more, read 8 Reasons To Own Gold.)