700 Billion Reasons to Own Some Gold: Chris Barker

700 Billion Reasons to Own Some Gold

By Christopher Barker

October 2, 2008 Motley Fool

To Egyptian Pharaohs, it brought immortality in the afterlife. For Roman Caesars, it facilitated trade throughout the known world. To the Incas of Peru, gold was the sweat of the sun, while to their Spanish invaders it was the prize of brutal conquest.

Amid this financial crisis of historic proportions, gold is once again gaining favor as a tangible store of honest value. Though often maligned as an outdated relic, gold has tripled in value since 2001. Meanwhile, the greenback has declined 33% against a basket of foreign currencies.

For those of you wondering what that has to do with your future, I have a list a mile long of reasons to consider having at least some gold exposure. For the purposes of this article, I’ve pared the list down to five:

1. Inflation looms ever larger. $700 billion is a ridiculously large sum. But while we’ve been busy debating the ethical quagmire of conditional capitalism, the Federal Reserve announced a $630 billion bump to its currency injections into the financial system on Monday. Combined with operations earlier in September, that brings the total announced just in the past month to more than $1 trillion. Even without the help of Treasury’s $700 billion lifeline, the Fed is placing dollars into circulation at an alarming rate, which many analysts believe is decidedly dollar-negative and predictive of a continued rise in the rate of inflation. As troubled as I am about these policies, there has been a clear negative correlation over time between the value of the U.S. dollar and the price of gold in dollars. For this reason, I view every subsequent commitment of dollars by the billions as a billion more reasons to own gold.

2. Physical gold is becoming more scarce. The combination of renewed investor demand and a global mining industry facing countless challenges to production has altered the supply and demand dynamic to favor the long-term gold investor. For starters, we have bullion ETFs taking massive quantities of gold bullion off the market. The physical holdings of the SPDR Gold Shares (NYSE: GLD) ETF soared to a new record above 755 tonnes of gold at the end of September. That’s more gold than China held in reserve as of June. Furthermore, the Central Fund of Canada (AMEX: CEF), a closed-end fund that owns gold and silver, issued another non-dilutive share offering in September to purchase more bullion. In recent weeks, this Fool watched with interest as a single major purchase wiped out the supply of the world’s largest gold refiner, the futures market in Vietnam lacked an adequate supply to redeem contracts for bullion, and the U.S. Mint ran out of the popular gold buffalo bullion coin. Demand is growing, and the above-ground supply of gold appears to be shrinking fast.

3. Banks are looking to build gold reserves. Across the globe, banking industry experts are forecasting major gold purchases by central banks and private institutions alike. The manager of Austria’s central bank believes that the banks of nations with smaller gold reserves could be considering adding gold to protect themselves against currency fluctuations. China may be starting the process already. Jeremy Charles of HSBC believes institutional investors such as private banks will want to reestablish gold holdings as well.

4. Guess who’s long on the TOCOM? Serious gold investors love to watch the Tokyo Commodities Exchange (TOCOM). The TOCOM lists the names of the entities conducting trades, permitting gold bugs to track the shifts in long and short positions for major traders like Goldman Sachs (NYSE: GS). Reversing a long-standing net short position, a Japanese subsidiary of Goldman shifted to a net long this week.

5. Insiders agree: gold is going much higher. From Goldcorp (NYSE: GG) founder Rob McEwen, to Fronteer Development Group (AMEX: FRG) CEO Mark O’Dea, mining industry executives are increasingly comfortable spelling out their long-term price targets for gold. Executives from Gold Fields (NYSE: GFI) and Barrick Gold (NYSE: ABX) have estimated that the all-in cost of mining gold from the ground amounts to about $800 per ounce for the industry, suggesting the long-term price floor continues to build upward.

In addition, analysts from Barclays Capital and GFMS believe that gold will reach new highs within the next six months, while Superfund Financial’s Aaron Smith expects to see $1,500 gold over the next two to three years.

Of course, not everyone is sold on gold. Goldman Sachs recommended shorting gold as one of its top ten trades for 2008, predicting the metal would plummet to the $600-$650 range. I certainly don’t think we’ll see those levels, but judging by the volatile swings in my CAPS score, gold mining equities admittedly haven’t provided much safety so far this year.

Nonetheless, as Goldman shifts from short to long on the TOCOM, and Washington tries to smother a financial fire with cash kindling, I still believe both bullion proxies and well-chosen gold miners will reaffirm gold’s relevance as a tangible “safe haven” asset.