The Case for Gold

 

A Valuable Commodity with Rising Demandand Declining Production

Worldwide demand for gold is rising while new mine production has stalled. Key gold producing countries like South Africa, Australia and the United States, which account for about one third of the global output, have seen production decline substantially over the last five years. As more investors enter the market and developing nations add to their reserves, the supply side of gold mining is running at a significant deficit to demand.

The trend appears poised to continue. Lower ore grades, difficult geology and the fact that many new deposits are in “unfriendly” places make significant supply increases unlikely for most commodities. Even as companies mobilized additional assets to meet the world’s growing demand, these delays and disappointments have constrained supply, and increased capital expenditures have not necessarily translated into increased production.

While supply remains tight, demand is increasing due to rising wealth levels in China, India and other nations with cultural affinity for gold. Growth in personal incomes and the absence of alternative savings institutions have made gold increasingly popular in many other emerging markets. While jewelry demand, which accounts for nearly 70 percent of total gold demand, has slightly declined in recent years, investment demand through exchange-traded funds (ETFs), coins and bullion has increased.

Declining output from existing mines, particularly in South Africa, and a virtual absence of large new discoveries continues to restrict the supply of gold available in the market.

Relationship Between Gold,Oil and the U.S. Dollar

Gold has an intrinsic value that paper money does not. Because of this value, foreign nations are using gold as a method to invest their nations’ growing reserves. It’s not only foreign nations which have added gold to their portfolios; many individual investors have also increased their investments in gold. Gold ETFs now hold more gold than all but six of the world’s central banks.

Historically, gold also has proven to be a viable hedge against rising inflation because it maintains its purchasing power.

Periods of a decline in the value of the U.S. dollar have been accompanied by strength in gold. Gold and the dollar have maintained roughly an 80 percent negative correlation over the past 10 years.

Gold is also affected by inflation in the oil market. The U.S. dollar is the primary currency used in the oil trade, so exporters like China and OPEC member countries are accumulating vast quantities of dollars. Some of these surpluses are being used to buy U.S. government debt but they also are diversifying by spending an increasing amount on gold.

Commodities as an Asset Class

Since gold is not highly correlated with other financial assets, its inclusion in a traditional portfolio of stocks and bonds can add diversification and reduce volatility. We believe hard assets, like gold and silver, play an important role in portfolio diversification. Exposure to commodities can increase overall returns while lowering or maintaining volatility in a portfolio.

We suggest you invest no more than 5 to 10 percent of your total assets in gold and precious metals and related equitites. Investing in excess of this amount may cause your portfolio to experience greater volatility. Investment portfolios with exposure to hard assets should rebalance at regular intervals to maintain proper weighting.

In rising scenarios, gold equities have historically outperformed bullion.

The price of gold is the critical driver for gold equities, but there is more leverage to the upside in a rising gold market for gold shares. We like to say bullion is for value investors, while gold stocks and gold-stock funds are for growth investors.

When the economy is in an inflationary period or when financial markets perceive a threat of inflation, gold and gold stocks may gain in value.

The gold market is both cyclical and volatile. Gold-oriented funds are for investors witha higher volatility threshold since substantial, short-term price fluctuations are common.