Let's face it. When it comes to treasure, few of us picture stock certificates and bond coupons. Instead, we usually conjure up images of gold bars stacked high in Fort Knox or glittering gold coins strewn about sunken galleons.
Over the ages, countless empires and kingdoms have risen and fallen in the shadow of gold. From the ancient Egyptians to the European explorers, gold has been an enduring symbol of wealth and power. We have bartered with it, waged bloody wars for it, and even worshipped it.
And today, gold is just as coveted as it has been for the past 5,000 years. Fortunately, you don't need to be a pharaoh to own it these days -- just a simple ETF shareholder.
One of a Kind
Gold is unlike any other commodity. While oil and gas are consumed as quickly as they are produced, gold is virtually indestructible. It has been estimated that roughly 160,000 tons (give or take) have been pulled from the ground since the metal was first discovered -- and most of that is still around in some form today.
Still, gold prices are subject to the same immutable laws of supply and demand.
There are currently 400 commercial mines producing about 2,500 tons of gold per year, and that total has been dwindling since 2001. Meanwhile, the world uses about 3,500 tons per year. Much of the shortfall is covered by recycled, melted down scrap and the release of gold from the world's central banks.
Jewelry (which accounts for about 70% of the world's demand) and dentistry are the most obvious uses -- but gold is prized for much more than its aesthetic value. The metal is highly malleable and ductile, a superior conductor of heat and electricity, and utterly resistant to corrosion. As a result, it's widely found in electrical, biomedical and even aerospace applications.
So while it's sometimes said that gold has no utility, that's far from true.
As you might expect, orders from jewelers and industrial customers have softened lately due to deteriorating economic conditions. Ironically, though, those same conditions have created a tidal wave of demand from investors. According to precious metals research firm GFMS, investment demand for gold spiked +64% last year.
Much of that buying came from retail investors interested in holding physical gold -- demand for coins and bars shot up almost +90%. Meanwhile, heavy cash inflows caused precious metals ETFs to deposit an additional 10.2 million ounces of gold in their vaults during the year.
Overall, global demand crossed the $100 billion mark for the first time in 2008. So in what will go down as one of the worst years on record for stocks, bonds, real estate and even many commodities, gold shined brighter than ever and traded at an average price of $872 per ounce -- about +25% above 2007 levels.
Gold Doesn't Lose its Luster
To understand why gold is so appealing to investors in times of economic and/or political uncertainty, you have to go back to around 700 B.C. That's about the time a Lydian king named Croesus first minted gold coins as a medium of exchange for merchants.
Ever since, gold has been a universal currency that is spoken in any language. The Florin, Ducat, Krugerrand and a slew of other gold coins would later follow. Of course, governments switched from the gold standard to fiat money long ago -- but that doesn't mean that gold is no longer a recognized store of value.
You've probably heard the expression that certain currencies aren't worth the paper they are printed on. This is a common occurrence during periods of hyperinflation. For example, in the early 1990s Yugoslavia's currency was devalued to the point where it had to issue a 500 billion dinar note. More recently, Zimbabwe has been printing 200 million dollar bills -- which are still worth less than the equivalent of $10 dollars.
Of course, I'm not saying the U.S. is headed down that path. But interest in gold picks up any time there is even a whiff of inflation or macroeconomic instability. And given the unprecedented turmoil and systemic breakdown of the financial system, it comes as no surprise that millions of everyday investors are turning to gold as a safe-haven hedge against the unknown.
Even in what has been a relatively benign period for inflation, the dollar has still lost about half of its purchasing power since 1981. If you've bought a gallon of milk or a postage stamp lately, you're probably well aware of this steady erosion. And with the government spending freely, there is little doubt that recent monetary stimulation will reignite inflation -- it's just a matter of when.
Of course, you could choose to store your assets in milk rather than dollars, but gold has a longer shelf life and is far more negotiable.
Don't fall for Fool's Gold
As the chart below shows, gold prices have more than tripled over the past decade, while stocks have gone nowhere.
And if the recent surge in demand is any indication, this rally is far from over.
Just last month, a consortium of Saudi investors closed one of the biggest deals ever, shelling out over $3.5 billion for a pile of gold. And they weren't alone. In fact, the World Gold Council estimates that retail investment demand for gold jumped to 304 tons last quarter, up from 61 tons during the fourth quarter of 2007. That's a surge of nearly +400%.
In Europe, purchases of gold coins and bars skyrocketed +1,170% on a year-over-year basis.
And keep in mind, even at prices approaching $1,000 an ounce, gold is still sitting at just half the level reached during the last boom in the early 1980s -- when it spiked to $2,186 in today's dollars.
But there's a key difference. Back then, people couldn't sell their jewelry and other gold fast enough. This time around, it's just the opposite; buying is so brisk that widespread retail shortages have been reported. Fortunately, the ETF world has given investors a number of ways to join the party...
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