Gold: Is $1000 an Ounce in the Offering?

Gold price has risen sharply in the past month, going up from $680 an ounce on September 5, to $741 on October 5. One of the reasons that pushed gold to 28-year high was the recent Fed rate cut and speculations that there will be one more reduction in federal funds rate before the year end. A lower federal fund rate will make the US dollars less attractive compared with other major currencies and investors will use hard assets such as gold to hedge against falling US dollars.

I have been investing in gold via a mutual fund since early 2002 when the price for spot gold was below $300 an ounce. In the past 5+ years, gold price has more than doubled. For me, gold is an important piece in my diversified portfolio. Though I probably started investing in gold at the best time I could have and have made some nice profits, I feel gold still has room to go even higher because demands from developing countries like China, India remain strong. Then how high the price of gold can go?

Last week, Barron’s online published an interview with John Hathaway, Senior Managing Director and Portfolio Manager of Tocqueville Asset Management. Hathaway is managing the Tocqueville Gold Fund (TGLDX), the fund that I chose for my taxable accounts. In the interview, Hathaway offered his view on a range of issues related to gold, from gold production to the relation between US dollars and gold, and outlooks of gold mining companies. There are several items in the interview that interest me, particularly inflation and gold and future price of gold. Following are excerpts from the interview.

A recent article in the Economist mentioned a study that concluded gold hasn’t been a reliable hedge against risk or inflation. What do you make of that?

Gold has been among the best-performing asset classes since 1999, when it bottomed out. Also, gold is forward-looking. In the last several years, it has discounted a widening of credit spreads and a shift in the market to a more risk-averse posture and lower asset valuations.

But gold, as you point out, has also risen during a time of rising stock and bond markets.

There have been an anomalous couple of years where gold was viewed as a subset of hard assets and hard assets were sought after. We had a period where gold actually tracked very closely with things it normally doesn’t. Maybe it is noncorrelated.

I wouldn’t try to pigeon-hole gold too much, because if you look at the last four to five weeks, gold has definitely taken off because of concerns about the relaxation of the Fed’s monetary policy and the expectation there will be more of that. Of course, we’ve seen that not just in the gold price, but in the breakdown of the dollar on a trade-weighted basis.

Hathaway didn’t really answer the question about gold and inflation, but it seems he doesn’t agree that gold is an effective tool against inflation. Then on the perspectives of $1,000 gold.

What gets us to the magic number of a $1,000 an ounce?

I don’t think it will take much. Let’s not forget, in 1980 dollars, gold is less than half of its nominal price today.

The disparity between the amount of paper that has been created since 1980 and the amount of gold that has been produced since then is just enormous. The ratio of financial assets to physical gold is at the low end of a historical range. If you were to mark all the gold to market that has ever been mined, which is a very conservative approach, and then take the valuation of all the global stock markets and all the global bond markets, gold represents about 3%, compared with a figure in the mid-20% range in 1980, which was the top of the bull market in gold and the beginning of the bull market in financial assets.

Gold is a good value, certainly, at these prices, just based on the considerations we’ve discussed. Even if you don’t think worst-case outcomes are in the cards, gold is still rare and hard to find, and believe me, these companies are having the toughest times trying to maintain production, much less build it.

For investors who want to profit from the rising gold price, which one makes a better choice, physical gold, precious metal mutual funds, or ETFs? In my opinion, gold ETFs such as streetTRACKS Gold Shares (GLD) would make the most flexible choice to invest in gold. Unlike mutual funds which invest in gold mining stocks, GLD is backed by bullion. Thus, the price of GLD is directly derived from the price of gold.

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17 Responses to “Gold: Is $1000 an Ounce in the Offering?”

  1. Tim |  Oct 08, 2007 at 4:20 pm

    I’d take the profit from precious metals and get out. It is based on old economics of the gold standard rather than supply/demand economics. There is no ties between gold and inflation other than people’s antiquated thoughts that it still is a hedge against inflation. It is all based on speculation without any real links between currencies and gold. That to me is not a good basis for long term investment. if the rise was based on actual supply/demand, then there would be some substance to the rise; however, there is not.

  2. Money Blue Book |  Oct 08, 2007 at 10:48 pm

    Sun,
    You’re the only one I know who has made gold a part of their regular investment portfolio…interesting…guess I’m just not too keen on investing in materials.

  3. JC Carvill |  Oct 09, 2007 at 4:03 am

    gold is an important part of investment.there are so many ways to invest in this.but we should invest in more than one way.that will manage our losses if happen.

  4. KMC |  Oct 09, 2007 at 9:33 am

    Hathaway never did answer the first question, did he?

    I believe, as the question pointed out, that gold is not a good inflation hedge. I’ve seen studies that conclude it’s a good hedge against uncertainty (war, political turmoil, etc) but not inflation.

    I’m glad you’ve been successful in this investment, Sun. I have no problem with gold as part of a diversified portfolio.

  5. Tim |  Oct 09, 2007 at 2:46 pm

    sun, i think your assessment of 6-7 years increase doesn’t tell the whole story. Just taking the past 20 years of gold prices, gold was flat and declining for 14 years prior to 2001. the only time it increased was during desert shield/desert storm, but then continued the decline after the war. Gold didn’t all of a sudden become scarce in 2001/2002 timeframe, we had 9/11 and the start of the two wars. people historically have flocked to gold in times of crisis for whatever reason, primarily because of the gold standard. I still contend that the increase is inflated and not based off of supply/demand fundamentals. The real spike (by this I mean over $400 where gold has been flatlined around until around 2005) is only 2 years old. I’m still not seeing a supply/demand fundamental justifying the increase. I see 9/11, two wars, and declining dollar due to currency deficit as the cause for the increase in gold. I say hold on until the wars end or at least Iraq and we’ll see gold plummet again.

    the gold price right now is artificial and will definitely burst.

  6. Sun |  Oct 09, 2007 at 2:51 pm

    Tim: If gold price rises $40 a week, that could be speculation. However, the price of gold has steadily increased for nearly 6 or 7 years. I don’t think speculation can last that long. There must be substance that supports the current price level. Though currencies are not tied to hard assets such as gold any more, people are still buying the metal to hedge against the falling US dollars. Should US dollars continue to weaken, the price of gold will keep going up. There are elements from speculative activities, but not all. And, gold is still popular in China. Not that everybody wears it, but as gift

  7. Tim |  Oct 09, 2007 at 4:05 pm

    sun, don’t know how my reply to your reply got ahead of your reply. pretty funny.

    many parts of the world use gold as gifts, well primarily for a form of dowry. that said, again, gold didn’t all of a sudden become scarce within a one year time span. again, the fundamentals justifying the spike is just not there. If you held onto gold from 80s to 2001, you would have had a significant real money depreciation in terms of both inflation and gold price decreases. remember 1979-1980 spike, which is similar to what is going on today followed by a plunge in gold prices. again, it is artificially inflated and will plummet, unless somehow gold becomes scarce in terms of supply/demand fundamentals.

    and let’s just think about what you could do with gold, rather stocks in gold, if the u.s. currency bottoms out. Absolutely nothing. again, ride the wave, but the fundamentals just don’t support the current prices or even higher prices.

  8. Sun |  Oct 12, 2007 at 11:55 am

    Tim: Unlike stocks, which you can evaluate by examining fundamentals such as earnings and cash flow, it’s not easy to say about the fundamentals of gold other than supply and demand. Is the demand of gold growing? I think so. People have been using gold for centuries as currency and jewelry and once they have a piece of gold, they hold it for a long time if not forever which means that piece of gold is taken out of circulation. I have a gold coin and I don’t think I will ever sell it. However, the bad thing about gold is that once it’s produced, it can’t be consumed like oil. It will exist almost forever. So as the production continues, there will be more and more gold on the market and in people’s hands. But I don’t think it will reach a point that there’s too much gold out there. Then the production of gold is getting more difficult and it’s not like there are lots of gold reserves to be discovered, as is pointed out in that interview. Oil is new, but gold is old.

  9. Tim |  Oct 13, 2007 at 11:44 am

    sun, you can assess supply/demand for gold. The bottom line is that gold didn’t become that scarce within a 2 year time span after staying flat and declining since 1980.

    i agree that gold is old…so is the thinking about it’s value. Again, ride the wave, but I’d be expecting a sharp decline to a more realistic cost around $350-$400.

  10. Minimum Wage |  Oct 14, 2007 at 1:40 pm

    If somebody is offering gold for $1,000 an ounce, I’m not buying.