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Gold: Not So Precious? Part 3

In part one of this series about gold as an investment, I talked about some alleged drawbacks of the precious metal as noted by two Wall Street Journal reporters. In part two, I discussed the points made by Jonathan Burton in his August 15 Journal piece. Today, I’m going to talk about the allegations made by Eleanor Laise in her January 29 article. To assist us, please note this FANTASTIC gold chart that can be viewed on the Journal’s website.

On January 29, Eleanor Laise highlighted several drawbacks of the yellow metal when serving in an investment capacity:

1. At the price that gold commands today, investors may be paying too much for any diversification benefit.

To begin, it’s interesting that Ms. Laise saw a diversification benefit, whereas Mr. Burton didn’t. Gold has risen more than 42% since mid-August 2007 (as of 1/30/08). However, to keep pace with inflation going back to 1980, gold futures would need to be above $2,228. Priced in 1980 dollars, gold appears cheap. A bargain? Not necessarily. However, supporters of gold point out that the yellow metal may have a lot more room to rise.

2. Gold hasn’t always performed effectively as a hedge against inflation.

A quick glance at the “Hot Commodity” tab on the Journal chart shows how poorly the metal has performed in this capacity since 1980. In addition, back in a post I wrote on November 16, I referred to a study conducted by Goldman Sachs, which showed that since 1988, the correlation between bullion and U.S. inflation expectations is just 36% (meaning the price of gold rises and falls with inflation expectations 36% of the time). The relationship between gold and U.S. consumer price inflation is only 23%.

3. The metal has extremely volatile price movements.

As I pointed out in part two of the series, a long-term investor might not be too concerned about short-term price gyrations. Along with the short-term trader, they may actually welcome such a characteristic, as it would allow them to accumulate more of the metal on price dips.

4. Many gold investments come with significant tax consequences.

A drawback, for sure. Ms. Laise wrote:

While the streetTracks Gold and iShares Comex Gold ETFs are popular among small investors seeking easy exposure to gold, the Internal Revenue Service treats them like collectibles, taxing long-term gains at a maximum rate of 28%. That compares unfavorably with the maximum 15% rate on long-term capital gains on securities and qualified dividends.

5. Because it’s seen as a safe-haven, gold attracts “emotional, speculative” investors who “can amplify its price gyrations.”

I wonder if that’s still the case. Laise’s colleague, E.S. Browning, wrote in the Wall Street Journal on January 31 that:

Historically, the world’s most enthusiastic buyers of the metal have been catastrophe-fearing “gold bugs” in places like India, where banks aren’t always trusted and currencies can be unstable.

Today, a different class entirely is powering gold’s rise: mainstream investors and money managers who once shunned it.

6. The dollar’s long decline may be near an end, which could hurt gold.

The dollar’s long decline may or may not be near an end. I’ve seen arguments for both scenarios. Personally, I believe that that any halt in the dollar’s decline would be only temporary.

7. Some advisers are no longer recommending gold to their clients.

Then again, some advisers are. Browning wrote on January 31 that Bessemer Trust, a New York institution that oversees $52 billion for wealthy families, had no money invested in gold three years ago. Today, it has about $300 million, due partly to new purchases and partly to investment gains, and plans to buy 10% more over the next few weeks. According to Browning:

Its managers say they believe the firm’s gold stockpile is the greatest in its 100-year history, in either dollar or percentage terms. That period includes the Great Depression, two world wars and the 1970s oil crisis.

Not only is gold being acquired by advisers for their clients, but also by central banks, whose sales in the late 1990s and early 2000s damaged gold sentiment.

Browning wrote:

Until recent years, central banks around the world were selling their gold holdings, at prices far below today’s prices. Now some central banks are buying.

8. Gold doesn’t always perform in a crisis. A recent study by Trinity College in Dublin found that, while gold generally holds up well when stocks decline substantially, the effect is short-lived.

It depends on what you mean by the term “crisis.” When Ms. Laise refers to the December 2006 study by Dirk Baur and Brian Lucey (which I have a copy of), a crisis is equated to a significant stock decline.

However, gold’s run-up over the past few years might not be as much event-driven as it is due to a crisis of confidence in the U.S. financial system.

The Journal’s Browning wrote:

Gold’s renewed luster shows the extent to which unease has replaced optimism since 2000. The 1990s marked a period of hope about the information-technology revolution, declining inflation and easier global money flows — all in a peaceful, U.S.-dominated world.

Today, optimism is clouded by terrorism, war, declining U.S. prestige, a technology-stock bubble followed by a real-estate bubble and the emergence of China and India as economic juggernauts. Investors’ affection for gold perhaps reflects their shaken faith in the U.S. financial system and a strong dollar — historically bedrock beliefs — as the housing debacle spreads.

9. Gold doesn’t produce earnings or pay dividends, and its returns over the long haul often look less enticing.

Regarding the fact that gold doesn’t produce earnings or pay dividends, Michael Kosares said in his book The ABCs of Gold Investing that:

The fact that gold does not pay interest is its greatest strength. If gold were to pay interest, the return on your gold would be dependent on the performance of another individual or institution.

Marc Stern, chief investment officer of Bessemer Trust, told the Journal on January 31 that one advantage of gold is that it isn’t regulated by any central banker who might be tempted to print money and thus debase its value. He said:

Gold doesn’t have a policy, gold doesn’t have a central banker, gold doesn’t have a printing press. It is a form of insurance.

Regarding gold’s long-term returns, in part two I talked about the importance of where one enters/departs the market. This is due to differing interpretations as to what “long-term” refers to. I’ve found that “long-term” can mean periods ranging from 5 to 25 years or longer, depending on the source. Regardless, Kosares noted in his book that:

Markets cycle. The performance of the stock market has been fundamentally tied to the performance of the dollar over most of the last century, and even though some on Wall Street would like you to believe in never-ending growth and profits, that is simply not the case in reality.

And the U.S. currency has been falling against other major currencies. Brett Gallagher, who helps oversee about $63 billion in international investments as deputy chief investment officer at Julius Baer Investment Management (a New York subsidiary of Zurich’s Julius Baer Holdings), told the Journal on January 31 that because of the Fed’s easy-money policies, “global investors in general are saying, ‘We don’t feel the dollar is a good store of value,’” and they are diversifying into other assets. His fund holds gold-related stocks and other commodities-related shares which may benefit from a weakening dollar. “Our interest in tangible assets such as gold increased in the fourth quarter” of 2007, Gallagher added.

As we have seen, opinions vary as to gold’s importance as an investment. However, to a growing number of investors the metal is still seen as “precious,” and serves as an insurance policy against an increasingly-unstable financial system dominated by paper “assets.”

(Note: The author disclaims any personal liability, loss, or risk incurred as a consequence of the use and application, either directly or indirectly, of any information presented herein.)

Gold: Not So Precious? Part 2

Yesterday, I brought up two Wall Street Journal articles that talked about gold as an investment. In the post, I discussed some of the precious metal’s alleged shortcomings, as pointed out by Jonathan Burton and Eleanor Laise. Today, I’ll take a closer look at some of these “drawbacks.”

In his August 15 Journal piece, Jonathan Burton wrote the following about gold and its place in a diversified investment portfolio:

…as an investment, short-term risk is high and long-term reward is marginal.

Regarding Burton’s claim that gold’s short-term risk is “high,” there’s no doubt that the yellow metal’s price volatility is legendary. Yet, if I’m a long-term investor, as opposed to a short-term trader, am I really concerned about short-term price gyrations? I would think the same applies for someone looking to diversify their investment portfolio. Wise investors see price dips as potential opportunities for accumulating more of an asset at depressed values.

Going back to the issue of diversification, I know Burton wrote that gold is not really “needed” in that capacity. However, I’ve seen studies that claim the precious metal may help increase returns and reduce portfolio risk. In the March/April 2006 issue of the Financial Analysts Journal, David Hillier, Paul Draper, and Robert Faff wrote in “Do Precious Metals Shine: An Investment Perspective” that gold can improve portfolio performance. According to their research:

Through analyzing daily data for the 1976-2004 period, we showed the following: Gold, platinum, and silver have the potential to play a diversifying role in broad-based investment portfolios… Financial portfolios containing a moderate weighting of gold perform better than portfolios consisting only of financial assets.

Chicago-based Ibbotson Associates also produced a study in 2005, entitled “Portfolio Diversification with Gold, Silver and Platinum.” They concluded that:

Investors can potentially improve the reward-to-risk ratio in conservative, moderate, and aggressive [risk orientations] asset allocations by including precious metals with allocations of 7.1%, 12.5%, and 15.7%, respectively. These results suggest that including precious metals in an asset allocation could increase expected returns and reduce portfolio risk.

Finally, Burton wrote that gold’s long-term reward is “marginal.” This would appear to be the case when comparing the metal’s performance to stocks, for example, which have achieved average annual returns of 7% (after adjusting for inflation) since the early 19th century. After hitting $847 an ounce in January 1980, gold futures fell for almost 20 years, grinding down to $253 in August 1999, a 70% drop. Gold remained dull until 2001. However, prices have more than tripled since then. Couldn’t it be argued that whether or not a reward is “marginal” depends upon the entry/departure point in a particular market? Case in point, U.S. stocks have been part of a larger bull market since 1982. However, those who were on the Street prior to that time might recall that stocks went practically nowhere from 1966 to 1982. Had I invested in the stock market during that era, I might have concluded that my long-term reward was “marginal.” Consider this. If an investor had $1,000 in the stock market on September 3, 1929, the value of their investment would have plummeted to $108.14 by July 8, 1932, or an 89.2% loss. I know… we’re supposed to be talking about the long-term here. Well, if the stock investor had waited around for their portfolio to break even, it would have taken until 1954, 22 years later. I have a feeling they would also have concluded that their long-term reward was “marginal,” unless, of course, they were in a complete state of denial.

Well, that’s it for today. On Sunday, we’ll take a closer look at some other “drawbacks” of the yellow metal in the final part of this series.

(Note: The author disclaims any personal liability, loss, or risk incurred as a consequence of the use and application, either directly or indirectly, of any information presented herein.)

Gold: Not So Precious? Part 1

Last summer, I came across an article in the Wall Street Journal that talked about diversification in an investment portfolio. On August 15, Jonathan Burton wrote in “What Your Portfolio Really Needs” that stocks and bonds are essential to a diversified portfolio. He also suggested that real estate would be “nice to have.” On real estate, he recommended that investors think globally, as “the world is getting wealthier, and as the saying goes, they’re not making any more land.” I used to hear that one a lot during the housing boom. Actually, if you really think about it, that statement isn’t necessarily true. Look at Dubai’s Palm Islands. Anyway, before I go off on a tangent, Burton continued to say that for diversification purposes, don’t bother with sector funds, gold, and other commodities, as they are things you “don’t really need.” On gold, he said:

It insures against financial catastrophe and marches to its own drum. But as an investment, short-term risk is high and long-term reward is marginal. If you want gold, buy jewelry.

“I agree…fool!”

Just this past Tuesday, another Journal reporter talked about gold’s investment attributes (or lack thereof). Eleanor Laise wrote in “How to Survive the New Gold Rush” that even though the yellow metal has been on a tear lately, “it also carries substantial risks for investors.” She pointed out the following drawbacks:

• At the price that gold commands today, investors may be paying too much for any diversification benefit.
• Gold hasn’t always performed effectively as a hedge against inflation.
• The metal has extremely volatile price movements.
• Many gold investments come with significant tax consequences.
• Because it’s seen as a safe-haven, gold attracts “emotional, speculative” investors who “can amplify its price gyrations.”
• The dollar’s long decline may be near an end, which could hurt gold.
• Some advisers are no longer recommending gold to their clients.
• Gold doesn’t always perform in a crisis. A recent study by Trinity College in Dublin found that, while gold generally holds up well when stocks decline substantially, the effect is short-lived.

Laise threw in some traditional arguments as to why the yellow metal is a bad investment:

• “Yet gold doesn’t produce earnings or pay dividends, and its returns over the long haul often look less enticing.”
• “What’s more, gold has failed to keep pace with inflation in recent decades.”

Tomorrow, we’ll take a closer look at the allegations being made against the yellow metal in part two of the three-part series.

World’s Highest Paid Advisor: ‘Financial Tsunami Is Upon Us’

Have you ever heard of Harry Schultz? I sure have, and to this day I am still in absolute awe of the money this man earns. Mr. Schultz, publisher of the International Harry Schultz Letter, is the highest paid investment consultant in the world at $3,500 an hour (or $4,900 an hour if you require his services during the weekend). I talked about him in my November 21 post where I discussed gold as a hedge and investment. Back then, Schultz said that gold will advance past the thousand dollar mark in 2008. Earlier today in his MarketWatch commentary, Peter Brimelow said that Schultz’s latest newsletter issue is “absolutely apocalyptical.” Schultz warned, “A financial tsunami is upon us,” which he attributes to lax credit and complications from the derivatives craze. MarketWatch’s Brimelow says:

Among other interesting ideas raised by Schultz in his intense, somewhat terrifying introduction: recession, possibly depression; bank failures; exchange controls; housing prices down by 50%; credit card company failures; money market fund dangers; tripling of U.S. jobless numbers; federal bail-outs for Fannie Mae.

 Bank run from “It’s A Wonderful Life”

Sound terrifying? According to Brimelow, Schultz’s advice for protecting one’s self from the coming financial storm and vulnerable U.S. banking system included, most urgently, closing out time deposits and buying non-U.S. government bonds. Regarding the future of the U.S. dollar, Schultz warned:

…the second biggest danger is owning U.S. dollars in any form, (it) has crashed and going much lower … use dollar rallies to exit dollars or sell short … This is not a time to seek profits, but to protect what U have … Portfolio diversification is essential in troubled times.

Brimelow noted Schultz’s favored currencies are, “In order of preference: Swiss Franc, Australian dollar, Euro, and Canadian dollar.”

On the topic of gold, Schultz recommended that:

Exposure to gold shares and bullion should be a minimum of 35-45% of your total portfolio, with at least 10% in physical gold bullion and coins, and/or very rare coins…

The public is still not in the gold market. They will be in 2008 as the derivatives and credit crises bring down more financial institutions (amid recession) and eyes will be opened, via pain. While Rome burns, gold will smash through its old unadjusted-for-inflation $850 high on the way to $1,600, & who knows how far beyond …

Wow. Apocalyptical indeed. By the way, Brimelow noted that Harry Schultz is up 21.42% over the past year according to the Hulbert Financial Digest, versus 7.51% for the dividend-reinvested Dow Jones Wilshire 5000. Looking back over five years, Schultz is up 34.38% annualized versus 12.85% for the Dow Jones Wilshire 5000.

Gold: Barbarous Relic Or Investment Superstar? Part 3

In part one of this three-part series about gold as a hedge and investment, I talked about its detractors. In part two, I discussed how U.S. dollar weakness, geopolitical risk, and supply/demand factors contributed to gold’s meteoric rise in price this year. In this last installment, I will look at the different forecasts for the precious metal.

As I type this, the spot price of gold is hovering around the $800 level. The metal reached its highest ever price of $850 per ounce back in January 1980. Gold prices touched $845.58 an ounce two weeks ago on November 7. Back on October 30, MarketWatch reported that Bear Stearns was predicting an average price of $775 per ounce of gold for 2008 and $750 for 2009. Consensus forecasts were for $721 in 2008 and $703 in 2009, the brokerage noted, citing Thomson Financial data. Meanwhile, Credit Suisse forecast that the precious metal would reach $838 an ounce in 2008, $950 in 2009, and $1,050 in 2010. Credit Suisse analysts argued:

A number of drivers collectively support the gold price… Our studies indicate in the long term global gold production will begin to decline as the diminishing number of new reserves fails to compensate for dying mines. The decline in global gold production will likely be accelerated, should the gold mining industry continue to incur significant year-on-year inflation rates which are not offset by similar or significantly higher gold price increases year-on-year.

On Monday, Philip Klapwijk, executive chairman of Gold Fields Mineral Services Ltd, a precious metals research consultancy, told the audience at the London Bullion Market Association’s precious metals conference in Mumbai, India, that gold may reach $1,000 an ounce by next year. He said continued weakness in the U.S. dollar, surging crude oil prices, and continuing geopolitical tensions are pushing the price of the metal higher.

A poll of the audience at the London Bullion Market Association conference on Tuesday showed gold was forecast to rise to $843.70 an ounce by September 2008. The survey was issued electronically to about 150 delegates including traders, bankers, analysts, producers, and fund managers at the two-day global conference on precious metals. Attendees also predicted that central banks would sell 470.40 tons of gold in 2008, down from an estimated 550 tones in 2007.

On Tuesday, Reuters said that the survey also revealed the following:

• 51% of the responses said investor interest was “the most important factor that would sustain the commodities super cycle,” followed by 35% who saw physical demand as having the maximum impact.
• 52% said the U.S. dollar was the “main factor” to influence gold prices, while 19% said moves in oil and other commodities would affect prices.
• Nearly half of those responding said micro hedge funds were having the most important influence on the price direction of precious metals, while 17% saw institutions having the maximum influence.

It’s interesting to note that MSN Money pointed out today that over the past 30 years, the correlation between gold and the U.S. dollar has been greater than 70%, according to CIBC World Markets analyst Barry Cooper.

Dr. Marc Faber, managing director of Marc Faber Ltd. and publisher of the Gloom, Boom & Doom Report, told Bloomberg on November 15 that gold may “easily” rise to a record $1,000 an ounce in 2008 as the U.S. dollar weakens and Asian central banks diversify their reserves. Dr. Faber is famous for advising his clients to get out of the U.S. stock market one week before the October 1987 crash, and for urging them in 2001 to buy gold, right at the beginning of a six-year rally.

Dr. Faber noted that:

The price of gold will continue to go up and probably very substantially. In the long run, it’s very clear that central banks are basically increasing the supply of money and the supply of gold is obviously very limited.

Yet, Faber also realizes the likelihood for corrections during gold’s ascent, like what happened after gold prices touched $845.58 an ounce two weeks ago. He said, “I don’t know of any market that goes up in a straight line. A continued correction from here wouldn’t surprise me; it’s a correction, a setback, in an ongoing bull market.”

Harry Schultz, who is in the Guinness Book of World Records as the world’s highest paid financial consultant and also publishes the International Harry Schultz Letter, says gold will advance past the thousand dollar mark in 2008. Over the past three years, Schultz’s investment letter is up 40.39% annualized versus 13.98% annualized for the DJ Wilshire 500. On October 8, MarketWatch reprinted the following from the newsletter:

With an election coming, the Fed went for bandaging a slipping economy which affects votes and sacrificing the dollar, which is harder for the public to measure. Big rate cuts, like this 50 points, are always an act of desperation. Such cuts have usually been followed by recessions. More cuts will follow. It set the future in cement for the U.S. dollar. Cement overshoes. Currency debasement never produces wealth. Fed knows this, but took a political decision. Nothing new about that. Much higher inflation now guaranteed … My tentative targets (by end of 2008): 14% (inflation), $1,600 (gold) and $45 (silver).

Schultz added:

Gold is starting into the most exciting part of its long-term bull market, the so-called second (and monetary) phase. Herein we normally see the biggest percentage gains, matched by biggest corrections as we saw in the ‘70s gold rush: in 1974, gold corrected 25% in 4 months (most gold shares fell 50-70%); in 1975-76 gold fell 50% (most shares fell 70-90%) and took 2 1/2 years to get back to old high before then rocketing to new highs. But that makes for great trading opportunities. This is the phase where the BIG money is made, by those who go with the tides. In and out, in and out…

Finally, there is Richard Russell, who gained wide recognition from a series of over 30 Dow Theory and technical articles that he wrote for Barron’s during the late fifties through the nineties. Russell was the first (in 1960) to recommend gold stocks. He called the top of the 1949-66 bull market. And almost to the day he called the bottom of the great 1972-74 bear market, and the beginning of the great bull market which started in December 1974. Russell wrote in his November 7 issue of Dow Theory Letters (as reprinted on Gold-Eagle.com) that:

If gold can close above its 1980 peak price of 850 — it will have overcome a resistance level that has held it back for 27 years! Thus, a decisive closing above 850 could bring about at least a doubling of the current dollar price for gold.

Therefore, Russell sees a potential gold price of at least $1,700. Yet, Richard Russell’s commentary from November 7 is notable in that he suggests gold’s future performance will reveal the fraud inherent in the U.S. monetary system:

It really is sad. Here’s gold and silver (“specie”) mandated as the only money by the Constitution of the United States. Yet our citizens have been kept in the dark about gold for generations. Instead, Americans have been touted on the value of fiat money, rudderless money. This fiat money is created by a private banking cartel (the Fed). This transfer of US money-creation has never been authorized by a Constitutional amendment.

Russell hammers his point home:

I’ve said this before, but I’ll repeat it — the whole system of fiat (paper) money is the greatest fraud ever perpetrated on the American people. Our defense against this “counterfeit” money is, and always has been, Constitutional money — gold and silver. Federal Reserve Notes (currently termed “dollars”) are a blatant lie. Today, rising gold is dragging that lie out into the open. Ultimately, the truth will out. Rising gold is shouting the truth – “gold is money, Federal Reserve Notes are a lie and an abomination.”

(Note: The author disclaims any personal liability, loss, or risk incurred as a consequence of the use and application, either directly or indirectly, of any information presented herein.)

Gold: Barbarous Relic Or Investment Superstar? Part 2

In part one of a three-part series on gold, I noted that the price of the metal has risen significantly in the past year, despite all the arguments leveled against gold by its detractors. Meanwhile, the metal looks to be headed for its seventh straight annual gain. Gold bulls point to the following as having a significant impact on its price in 2007:

U.S. Dollar Weakness- The U.S. currency is down four out of the last five years, and has dropped almost 11% so far this year based on the Federal Reserve’s U.S. Trade-Weighted Major Currency Index. This autumn it’s been at its weakest against the euro since the European currency started trading in 1999, the lowest against the Canadian dollar since it was floated in 1950, and at a 26-year low versus the British pound. The end of the U.S. housing boom, the subprime mortgage crisis, and a credit crunch, in conjunction with forecasts for a slowing U.S. economy, have weighed down the U.S. currency. The increased threats from dollar diversification by countries holding large numbers of greenbacks in their foreign currency reserves, sovereign wealth funds looking to exchange their dollars for other assets, and more nations looking to decouple their currencies from the U.S. dollar have only made matters worse for the world’s reserve currency. Assuming the existence of a strategic inverse relationship between gold and the greenback, investors have poured money into the precious metal and related investment vehicles. Validating such actions have been forecasts by legendary investors such as Warren Buffett, Jim Rogers, and George Soros, who all predict that the U.S. dollar is going lower. Back on October 25, Buffett was quoted by CNBC as saying, “We are still negative on the dollar. We bought stocks in companies that are earning their money in other currencies.” On November 15, Rogers told Bloomberg that, “If you have dollars, I urge you to get out. That’s not a currency to own.” Finally, on June 2, AME Info reported that Soros said, “A slowdown in the United States will be transmitted to the rest of the world via a weaker dollar.”

Geopolitical Risk- The continuing stalemate between the West and Iran over its nuclear program, political instability in Pakistan, and Turkey’s spat with Iraq are just some of the more recent geopolitical risks that have driven the price of gold higher. The ever-present danger from Al-Qaeda should not be forgotten either. Consider the following warning from Michael Scheuer, a 22-year veteran of the Central Intelligence Agency (CIA), where for 6 years he was in charge of the search for Al-Qaeda leader Osama bin Laden. When asked by Radio Free Europe/Radio Liberty earlier this year if he expected more attacks on the United States or in the West on the scale of September 11, 2001, Scheuer’s response was:

Oh, I think greater than 9/11. I don’t think it will happen in Europe, but I do think it will happen in the United States. Bin Laden has been very clear that each of Al-Qaeda’s attacks on America will be greater than the last, and I think the only reason we haven’t seen an attack so far is that he doesn’t have that attack prepared. But when he does, he will use it. And try to get us out of the way, which of course is his main goal.

Stephen Walker, director of global mining research at RBC Capital Markets, said last week that increasing geopolitical risk, combined with combined with rising economic uncertainty, “should continue to provide incentives for investors to increase their exposure to gold as a safe haven.”

Supply and Demand- Last Friday, the Telegraph (UK) announced:

The era of ‘peak gold’ has arrived. Try as they might, miners cannot find enough ore at viable costs to replace their fast-depleting reserves, even if they dig miles into the centre of the earth.

The global mine supply of gold peaked in 2002, and has fallen every year since. Last year alone, the mine supply of gold fell 15%. Also in 2006, South Africa, the world’s single-largest gold producer, produced its lowest amount of gold since 1922 with overall output down 72% since its 1970 peak. It should be noted that no major new mine production is expected in the near-term either.

On the demand side, RBC Capital Markets noted last Wednesday that demand is rising as consumption increases in China, India, and the Middle East. On Thursday, a study by precious metals consultant GFMS Ltd. showed that global gold demand in the third quarter rose 19% year-on-year on the back of robust inflows into bullion investment funds and improved jewelry consumption. The report revealed that the increase in investment demand replaced jewelry buying as the major source of growth for the third quarter. Demand grew sharply in India, China, Turkey, and the Middle East, while it slowed in the United States.

Outside of U.S. dollar weakness, geopolitical risk, and supply/demand factors, gold bulls say that some of the drawbacks which Bloomberg’s Michael Sesit spelled out in part one are actually advantages to owning the precious metal. Critics of gold like to point out that it “doesn’t earn a return.” Michael J. Kosares, President and Founder of Centennial Precious Metals, Inc., argued in his book The ABCs of Gold Investing, that:

Those who criticize gold because it fails to offer a return do not really understand gold’s position as the fixed North Star of asset value around which all other assets rotate. Gold is a stand-alone asset. It relies on no individual or institution for value. Gold investors prefer it this way. In the ultimate sense, this is what money is and what money should be.

Another criticism directed at gold, said Sesit, is “the world’s biggest holders of gold, major central banks, aren’t overly eager to keep owning it.” If so, gold bulls ask why central banks hesitate to unload the metal. In 2006, net central bank sales amounted to just 319 tons, less than half of the 659 tons recorded in the previous year.

Love it or hate it, bulls and bears, gold is here to stay. In the final part of this series, I will talk about where this precious metal may go from here.

(Part 3 will be posted on Wednesday)

Doubting The Dollar

It’s being reported today that the central bank governor of the United Arab Emirates, Sultan Bin Nasser al-Suwaidi, said that the continuing weakness of the U.S. dollar could lead to a review of the dirham’s peg to the dollar. The U.S. currency has fallen 10% against the euro this year, making imports for Gulf Arab states more expensive and helping push inflation in the U.A.E. to the second-highest level in the region. Kathy Lien, currency strategist at Forex Capital Markets, told MarketWatch:

The dollar stands to suffer from reserve diversification. The central bank governor of the U.A.E said today that they may drop their dollar peg in favor of a currency basket including the euro to contain inflation… Even though the reserves held by the U.A.E. are relatively small, if the move becomes official, it would be symbolically important because it suggests that other Gulf nations could follow suit.

Other analysts are more certain about the intentions of the U.A.E. Caroline Grad, an economist with Deutsche Bank AG in London, told Bloomberg today:

Today’s comments reinforce our view the dirham is the currency most likely to move away from its dollar peg following Kuwait’s move earlier this year. Although the U.A.E. has said it doesn’t intend to unilaterally abandon the dollar peg, we don’t rule out a move without the rest of the Gulf Cooperation Council.

In May, Kuwait abandoned the dinar’s peg to the U.S. dollar in favor of a basket of international currencies. Today’s statement by the U.A.E. official fuels speculation that the Gulf Cooperation Council states, which include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates, may follow Kuwait and drop the peg between their currencies and the greenback.

“I wouldn’t bet against the U.S. as the world’s reserve currency,” former U.S. Treasury Secretary John Snow, now chairman of Cerberus Capital Management in New York, told Bloomberg yesterday. “The dollar markets are so deep and so liquid and the American economy is so fundamentally advanced,” he adds.

Yet, even Bloomberg recognized today that:

Concern is growing that the dollar’s weakness may augur the end of the U.S. currency’s 62-year reign as the world’s main international currency for trade, financial transactions and central-bank reserves.

South Korea’s central bank urged shipbuilders this week to issue invoices in won, the South Korean currency, and increase hedging policies against the weakened dollar. Last weekend, Qatar’s prime minister, Sheikh Hamad bin Jasim bin Jaber al-Thani, complained that the declining value of the U.S. currency is significantly curtailing the country’s oil and gas income, leaving less to invest abroad. The central bank in Iraq last month said it, too, wants to diversify its reserves away from mostly U.S. dollars (no typo here- that’s Iraq, which the U.S. has occupied since 2003). It was even reported by the Telegraph (UK) back on September 21 that the United States’ closest ally in the region, Saudi Arabia, refused to cut interest rates in conjunction with the Federal Reserve for the first time, “signaling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.”

Despite the bleak outlook, the dollar rose against most of its major foreign-exchange counterparts Thursday.

Sovereign Wealth Funds Buying Up Gold, Other Commodities

No surprise here. Late Monday night the Financial Times (UK) reported:

State-owned sovereign wealth funds are beginning to diversify their investments into commodities, potentially having a significant impact on international raw material prices because of their immense resources.

Sovereign wealth funds, or SWFs, are investment vehicles backed by governments in the Middle East, China, Russia, and elsewhere. According to The Times (UK) from October 28:

Sovereign funds have been around since 1953, when the Kuwait Investment Authority (KIA) was established to benefit future generations of Kuwaitis when the oil stopped flowing. But it is only since the turn of the millennium that the power of sovereign funds has mushroomed. The rising price of oil and gas has prompted Middle East countries to look for new ways to invest their piles of cash. Russia has money to spare as energy prices have soared. At the same time, funds in Singapore, and more particularly China, have been boosted by income from huge trade surpluses.

The Financial Times is reporting that the total investment of SWFs in natural resources is still below 5% of their total allocations. Still, Katherine Spector, head of energy strategy at JPMorgan in New York, noted that, “While macro-data on sovereign money is elusive, anecdotally we see meaningful flows into commodities from the Middle East, Europe and Asia.” The Deutsche Bank said with worldwide state reserves above $3 trillion, any movement into the relatively small commodities markets could influence prices. The International Monetary Fund (IMF) estimates that total investments by sovereign funds have reached $2 trillion and are forecast to hit $12 trillion by 2012.

On the reasons for SWFs buying up commodities, a senior banker interviewed by the Financial Times said, “They want to use commodities, and particularly gold, as a hedge against the US dollar weakness,” adding that the investments were mainly streaming in from the Middle East and Asia. Another banker stated, “They want commodities exposure exactly for the same reason as other institutional investors- diversification.”