The Truth About Gold

U.S. debt is skyrocketing with no end in sight. And while the dollar has recently functioned as a short-term safe haven, its long-term fundamentals are deteriorating.

#-ad_banner-#To put it in perspective, U.S. public debt in 2000 was $3.4 trillion. That has now more than doubled to $8.6 trillion. The rate of increase is skyrocketing, with deficit spending of $1 trillion in 2008 and $1.9 trillion in 2009 alone. Current Congressional Budget Office estimates total debt of $5.8 trillion in 2008 to more than double to $12.6 trillion by 2014. That means in the six years (from 2008 to 2014) the country will borrow and spend as much money as it had since its founding in 1776 all the way up until 2008.

A currency is typically as strong as the economic fundamentals behind it. The Government Accountability Office (the U.S. government’s auditor) recently said the United States is on a fiscally “unsustainable” path. This skyrocketing debt will likely cause a devaluation in the dollar, and many are forecasting runaway inflation if we don’t get our fiscal house in order.

As a result, many predict the dollar will resume its plunge during last decade when it fell more than -40% against other major currencies.

So if the dollar can’t satisfy the world’s penchant for safety amongst unprecedented uncertainty, what can?

How about gold?

Gold serves as a safe-haven investment, holding intrinsic value in uncertain economic times and isn’t tied to the fortunes of any country or currency.

Gold prices have more than quadrupled since 2001 when it traded for less than $300 per ounce, but this could be just the beginning. Today’s uncertain markets are prompting a trickle into gold that could turn into a flood in the months and years ahead. Just this year, the price of gold has risen +23% to about $1200 an ounce from the average monthly price of $972 in 2009.

Recent strength in the price of gold portends well for the future. The last time gold had a sustained bull run, the price increased 40-fold from an average of about $35 an ounce in 1970 to a high of more than $800 an ounce in 1980.

Gold Prices in the Past 36 Years

I think the bull run in gold could just be getting started. And as my colleague Nathan Slaughter mentions often, gold is still well off its historical highs when adjusting for inflation. Just take a look at the chart below.

SPDR Gold Shares (NYSE: GLD) is an exchange-traded fund (ETF) that seeks to replicate the performance of the price of gold bullion. The fund is a pure play on the price of gold as it holds the physical metal itself as opposed to equity shares of gold mining companies or other less direct gold plays. Each share represents about one tenth of an ounce of gold bullion at current market prices.

This ETF is a fantastic modern day investment that makes owning gold just as easy as buying a stock or mutual fund. Unlike the old fashioned way of investing in gold which involved taking possession and storing the actual metal, GLD enables investors to own gold through an easy to purchase vehicle with NYSE liquidity. Investors can buy or sell shares at will any time the market is open.

Gold is a great way to hedge a portfolio against inflation and a falling dollar, but it is a tricky investment. It’s not necessarily a hedge against down or volatile markets. In fact, gold prices actually fell below the yearly averages in the peak months of the financial crisis in late 2008 and early 2009. As well, gold doesn’t necessarily perform badly in up markets. While U.S. and world markets soared in the past decade, before the financial crisis, gold prices rallied at the same time.

More than anything else, gold is a safe haven currency substitute during times of uncertainty or inflation. And these uncertain times are enticing investor appetites. According to The Wall Street Journal, central banks are increasingly shifting money out of euros and into gold. This led to gold hitting an all time record high price of $1243 an ounce on the New York Mercantile Exchange in early July. If uncertainty continues, so could the exodus into gold.

Action to Take –> In the short term, the price of gold can be volatile and unpredictable. But, given the extraordinary degree of uncertainty in today’s economy and the possibility of inflation in the future, it’s a prudent hedge to have some exposure to gold. GLD is a great way to not only hedge a portfolio, but also gain exposure to a possible massive run in gold in the years ahead.