Gold has been considered to be extremely valuable to man since prehistoric times. Much like any currency, it is viewed as a store of value, a medium of exchange and a status symbol. Unlike money however, it is considered to be a benchmark of stability and is used as a hedge against inflation.
The yellow metal is rare, with supply increasing by no more than five per cent a year since 1492. In fact, over the past 100 years, the annual increase in the supply of gold has hovered around two per cent. And although man has (to an extent) replaced gold with paper, and despite great advancement in measures for storing wealth, when the economic climate becomes uncertain, people tend to return to gold.
Indeed, an investor stands to benefit from holding a portion of his portfolio in gold, whether he opts to buy physical gold, gold certificates or invest in a gold exchange traded fund (ETF). Those investors who were savvy enough to buy gold earlier this year, whether as a hedge or an investment would undoubtedly agree. This year, gold moved from US$860.40 on January 1, 2009) to US$1,050.70 on October 16, 2009, an increase of 22.12 per cent.
The greenback, which is negatively correlated with the price of gold, has been a major player in the increase in the price of spot gold to a record high of 1,070.80 (October 14, 2009). Over the last seven months, the US Dollar Index, which measures the performance of the US dollar against a basket of six major currencies, has declined 15.26 per cent from its 52-week high of 89.11.
To top things off, on October 6, 2009, a report, which was later denied, surfaced that oil-producing nations were discussing replacing the greenback as the pricing currency for oil, thereby causing a plunge in the US currency, and of course, a rise in the price of gold. On that day, the price of gold rose US$20.80 to US$1,038.60.
Also, the US Federal Reserve's accommodative interest rate policies have set the stage for additional rises in the price of gold. With the Fed recently stating that it would continue to pursue this strategy for "an extended period", record low interest rates aimed at stimulating the economy could have the adverse effect of fueling long-term inflation. Plus, on the fiscal side, the Government's widening budget deficit will encourage investors to move away from the dollar. If this turns out to be the case, investors will favour gold as an alternative vessel in which they store wealth.
Lately there has been a buzz about gold ETFs, which allow investors to hold gold without having to physically possess and store it. They have proven lucrative to investors, outperforming the Dow Jones Industrial Average (DJIA) and the Standard & Poor's 500 Index (S&P 500) over the past year. Actually, if a person invested in a gold ETF, for example the iShares COMEX Gold Trust (NYSE: IAU) on October 20, 2008, he would have enjoyed a return of 35.43 per cent at October 19, 2009. The DJIA rose only 14.00 per cent during the period, while the S&P 500 rose 16.73 per cent.
At the same time, individual investors are not the only ones who see the benefit of owning gold. Central banks worldwide own approximately 25 per cent of the four billion ounces of Earth's gold. In fact, most countries' stocks of gold represent a significant portion of their international reserves. On average, the central banks that possess most of the world's gold have holdings equivalent to about 35.17 per cent (mean average) of their foreign reserves.
That noted, there are some countries whose holdings of gold are currently significantly "underweight" when compared to their peers. In particular, China, Japan and Russia have holdings equivalent to 1.9 per cent, 2.3 per cent and 4.3 per cent respectively of foreign reserves. If these countries were to increase their holdings to 10 per cent, they would need to purchase a total of US$286.38 billion of gold, thereby stimulating demand for bullion. In fact, China, which is poised to lead the global recovery, has begun to increase its gold reserves as a long-term strategy.
The overall expectation among analysts is that the price of the precious metal will inch higher next year, even if they taper off after the current rally. Analysts at Citigroup Inc predict that gold will average US$996.50 this year, but it will climb to 1,036.60 in 2010. Analysts at Morgan Stanley expect the average to be US$1,000 next year. With the outlook for the US dollar dimming in the minds of many investors, gold could be poised to continue to glisten in 2010.
