an interesting article in the Wall Street Journal on the price of
gold.
Lisa, Topanga, CA USA
What to Make of Gold’s $500 Run
By DAVID A. GAFFEN
THE WALL STREET JOURNAL ONLINE
December 1, 2005
http://online.wsj.com/
This week in Asian trading, gold futures touched $500 an ounce
for the first time in 18 years. And while the precious metal
has failed to close above the psychologically important
milestone, it is well within striking distance on the Comex
division of the New York Mercantile Exchange. Analysts think
the rally may have more room to run. Here’s what they have to
say about the most recent gold rush.
Q: Why is gold rallying?
A: Concern about inflation is the biggest reason. The Federal
Reserve has raised interest rates for 12 consecutive meetings,
and the European Central Bank was widely expected to raise its
key rate Thursday for the first time in years. Investors
typically turn to hard assets like gold when they think
accelerating price growth could be a problem. Market watchers
cite other reasons for gold’s long climb: For one, the metal
has become more popular with investors looking to diversify
their portfolios, particularly for those searching for
undervalued assets outside of the oil, stock and real-estate
markets. Also contributing to gold’s gains: steady demand for
gold jewelry. About three-quarters of world gold consumption
is used to produce jewelry. Overall, world-wide gold
consumption through the third quarter of 2005 was $38.4
billion, up 25% from 2004, according to the World Gold
Council, a London-based marketing group that represents the
gold-mining industry. In dollar terms, through the third
quarter, investment in gold is up 73% year-over-year, the
council says. In terms of actual gold tons, investment has
increased 62%.
Q. Who is buying all of this gold?
A. Demand for jewelry has traditionally been strong – and
remains so – in the U.S., India and China. Meanwhile,
investments in gold – which refers to gold purchases other
than jewelry and commercial use – have been rising sharply.
Investments are expected to rise 62% in 2005 in terms of
tonnage after a 56% increase in 2004. That includes hoarding
bars and investing in coins. Investor demand is up 11%
year-over-year in India, according to the gold-mining trade
group. In the Middle East, investment demand has risen 38% on
an annualized basis. Meanwhile, representatives of central
banks in South Africa, Russia and Argentina recently said they
are considering increasing their proportion of gold reserves.
Those banks have 9%, 3.6%, and 3% of their reserves in gold,
respectively, compared with 64% for the U.S. and 50% for
Germany.
Q: What’s the best way to invest in gold?
A: Buying and holding actual gold bars would be cumbersome.
Professional investors often use the futures market. But since
investing in the futures market is foreign territory for many
individual investors, those looking to make a bet on gold
traditionally bought mining stocks or mutual funds that
invested in several mining stocks. Mining stocks are
problematic, though, says Peter Grandich of the Grandich
Letter, a mining and metals publication, because they not only
reflect the rising price of gold, but also the state of mining
operations and the company’s financial condition. New avenues
like exchange-traded funds, which act like mutual funds but
trade throughout the market day like stocks, offer a more
direct path to investing in gold. At the end of 2003, ETFs
like the iShares Comex Gold Trust and State Street’s
StreetTracks Gold Shares accounted for just 12% of retail
investment in gold; they now comprise about 30% of the market,
according to the World Gold Council. Through the third quarter
of 2005, ETF investments were $1.73 billion, compared with
just $250 million in the first three quarters of 2004. The
shares in an ETF such as iShares Comex Gold Trust roughly
track the price of gold futures.
INFLATION BET?
Go Figure: Investing in gold with mutual funds and ETFs
Q: Does this rally mean investors are too late to the party?
A: Big round numbers like $500 don’t carry much more than
psychological value, though crossing such milestones often
nudges investors to cash out, says Mr. Grandich. On an
inflation-adjusted basis, gold’s record of $847 an ounce in
1980 is equivalent to about $1,930 in today’s dollars, using
the seasonally adjusted Consumer Price Index. Using that
measure, gold is historically cheap, Mr. Grandich contends.
While more people are choosing gold as an asset, it should
only remain a small portion of the portfolio, used for
diversification against stocks, bonds and other assets.
Q: Gold prices usually appreciate when stocks aren’t
performing well. What gives?
A: With major stock gauges like the Dow Jones Industrial
Average and the Standard & Poor’s 500-stock index hovering
around four-and-a-half year highs, it’s clear that the old
adage about gold and stocks moving in opposite directions
isn’t holding right now. Barry Ritholtz, chief market
strategist at the Maxim Group, points out that when the
economy slumped in 2001 and 2002 and the S&P 500 tumbled 33%,
gold surged nearly 28% as investors looked to offset poorly
performing stocks. However, since January 2003, though, each
has risen about 42%. That’s because tax and interest-rate cuts
served to “re-inflate” the economy, Mr. Ritholtz says,
creating enough price appreciation to make inflation-wary
investors consider gold. Stocks, meanwhile, benefited from the
improvement in corporate earnings in the last couple of years.
In fact, moderate inflation may allow more companies to raise
prices and, thus, boost earnings.
Q: So, $500 gold doesn’t necessarily herald an inflation
problem?
A: Because the price of gold generally rises along with prices
in the overall economy, the metal traditionally has been used
as an inflation hedge. And there are strategists who hold that
rising gold prices is indicative of looming inflation
problems. A report published in October by Lakewood,
Wash.-based researcher McClellan Financial Publications says
the government’s tally of consumer-price growth tends to trail
gold’s path by about 14 months. Gold started to rally in 2001
and the Labor Department’s consumer-price index began to climb
in late 2002. Right now, overall U.S. consumer prices are
growing at a 4.3% pace year-over-year, up from a 2.4% rate at
the end of 2002 – back when gold was at $347 an ounce. Many
economists think inflation is a problem contained only within
the energy sector, but gold enthusiasts are more pessimistic.
Q: The dollar is strengthening against the euro and the yen.
Traditionally, gold has fallen in value when the dollar has
gained strength. Why isn’t that happening now?
A: The dollar-gold relationship isn’t exclusive. Gold reacts
to multiple currencies, says Jeffrey Christian, managing
director at the CPM Group, a commodities research firm. The
yellow metal tends to rise when investors aren’t particularly
thrilled with any one currency over another. Gold’s increase
over the past few days has largely been attributed to
investors selling the Japanese yen; since April 2004, while
the dollar rallied from around 104 yen to about 120 yen, gold
gained 16%. “The bottom line is, there is not a great deal of
fervor in favor of any single currency at this point,” Mr.
Christian says. That has made gold more attractive to people
who would otherwise invest in currencies, he says.
Q: Are high oil prices playing a part?
A: For many years, gold prices and oil prices have tracked
each other pretty closely, as both on some level represent an
expression of (or reaction to) inflation. The relationship
between the value of gold and oil futures had generally been
about 15-to-1, meaning that gold at $500 would correspond to
oil at around $33 a barrel. But it’s not the case anymore.
Earlier in the year oil was soaring while gold was merely
doing pretty well. If the ratio held, with oil at, say, $56 a
barrel, gold would have to rise to $840 an ounce. For the
oil-gold ratio to get back on track, either gold needs to
surge or oil needs to fall much more sharply. (Since oil’s
peak at the beginning of September, this is exactly what’s
happened, although the old ratio hasn’t been re-established
and may not for some time.)
Write to David A. Gaffen at david.gaffen@wsj.com