Editor's Note: The First Installment of an Ongoing Series Addressing the Outlook for Investment Opportunities and the Global Economy in 2008.
By Mike Caggeso
There's no fancy way to say it: Gold investors made a killing in 2007. Year-to-date, gold's spot price is up 25%.
For some better perspective, consider the year-to-date gains of the three major U.S. stock indices: The blue-chip Dow Jones Industrial Average (6.17%), the tech-laden NASDAQ Composite Index (7.48%), and the broad-based Standard & Poor's 500 Index (2.59%).
Gold eclipsed them all.
Gold hasn't punched out the broad equity-indices like this since the late 1970s – a period still remembered reverently by gold bugs and institutional investors alike, when the "yellow metal" surged to record highs during an inflation-fueled economic malaise.
"The best one can say is that in the past several years gold's been going from the bottom left of the screen to the top right," said Dennis Gartman, editor of the daily investment newsletter, the Gartman Letter.
Gold investors have several causes to thank for such a leap – the U.S. subprime mortgage crisis, three interest rate cuts from the U.S. Federal Reserve, China's appetite for commodities and, of course, the declining dollar.
For gold investors, there's more good news to come: None of those catalysts that made 2007 such a grand year for gold are expected to be absent in 2008. Major lenders aren't expecting a full recovery from the housing market until 2009, which will keep pressure on U.S. Federal Reserve Chairman Ben S. Bernanke to keep interest rates low.
And we all know economic growth China and India won't be slowing down anytime soon.
But gold bugs shouldn't rejoice too much. A flood of new investors came into gold in 2007 – especially after the subprime mortgage meltdown – and they enjoyed a trifecta of blessings this year: Gold's reputation for safety in potentially inflationary environments, scorching growth abroad, and the unlikely event of 25% gains.
There's no guarantee 2008 will be as favorable as 2007, but that doesn't mean gold's going to cool either.
When asked to forecast where gold prices will go in 2008, Gartman had a simple but powerfully bullish answer: "Higher," he said.
[Gartman said he doesn't publicly forecast price targets for the simple reason that being off by $10 makes one's prediction inaccurate – even if one's correct about the direction and magnitude of the price changes in gold.]
However, it is worth noting that gold prices have increased every year since 2001 [See Table I Below].
Gold Gains/(Losses) 2001-2007
The so-called "yellow metal" has gained in value every year since 2001.
Source: Kitco.com and Money Morning Staff Research
However, Money Morning Investment Director Keith Fitz-Gerald notes that gold's story actually has a much more complicated plot than most investors understand.
"On an inflation-adjusted basis, that price is flat. That's the part that people don't get," Fitz-Gerald explained in an interview. "The trick is that you really should be buying gold to protect the principal on your bonds."
With U.S. inflation creeping steadily higher, gold will likely touch $1,000 later in 2008, after experiencing a slight decline early in the year, Fitz-Gerald said.
To understand how to invest in gold without breaking even, one needs to look at the underlying global economic outlook, currency trends and other key factors that dictate gold's value, while also determining demand for the yellow metal.
Gold Investors Don't Have to Dig Anymore
The World Gold Council reports that central banks and "supranational organizations" hold around one-fifth of the aboveground stocks of gold as reserve assets. But that figure is decreasing.
More gold has been trickling into the market yet demand hasn't been sated. However, the economic conditions that sent gold prices soaring this year aren't the same as those that were at play at the start of the decade.
Though gold has historically performed well when the dollar was in decline, 2007's subprime-fueled credit crash may have created economic woes for consumers on a scale not seen since the late 1970s, an era of "stagflation" in which gold hit its all-time high of $850. Stagflation describes a period of economic stagnation that's also rife with inflation – a combination that had been thought impossible prior to its appearance in the United States during the Richard Nixon Administration.
"Now gold is coming back because it's a proxy for conflict. If gold reaches $2,000, we'll have [much] bigger things to worry about," Fitz-Gerald said.
But, deeper than that, gold's rise is "driven part-and-parcel by China's need to diversify its currency reserves and the emergence of gold-backed dinars in the Middle East. The euro does not have enough liquidity to absorb this and China isn't likely to purchase additional Japanese yen. This leaves gold and – by implication – the new gold-based assets as likely beneficiaries of this process," Fitz-Gerald said.
Another factor that is different this time around involves the methods of buying gold. Investors now have the choice of buying shares of any of the dozens of publicly traded mining companies, buying one of many gold-oriented exchange-traded funds (ETFs), buying coins and bullion bars through banks that hold your gold for you, or picking up gold coins and gold bars at specialty collectors' shows.
With more avenues for investors to buy gold, it became easier to invest in the precious metal. And when the souring economics of 2007 sobered Wall Street, those avenues were flooded with a new throng of gold investors.
"Since the price is up, that's the only thing one can say," Gartman said.
Actually, there's still more to say. Demand for gold is escalating in a big way in China, India and other emerging markets. Asia's booming economies and populations are producing hundreds of millions of new consumers, adding to the middle-class of each country. And those consumers – like their more-experienced counterparts in the West – want to do one thing: Spend more than before.
Too Many Gold Fans Could Cool the Hot Metal
In early December, a telling story came out of India, the world's largest consumer of gold.
Gold imports to India significantly plummeted for two consecutive months. November purchases fell drastically from 59 metric tons in 2006 to 12 tons during the same month this year. Likewise, year-over-year purchases for October fell from 68 tons in 2006 to 14 tons this year.
Some of that occurred during India's prime wedding season, as well as the Diwali festival holiday – which combine to mark the peak gold-buying season for that country.
Why the slump? Gold became too pricey. Not just too pricey, but too pricey for a country in which gold ownership is embedded as a cultural norm.
Gartman said investors would be wise to heed India's counsel, and wait for prices to fall before investing. In doing so, investors are more likely to get in at a better price.
Capturing Gold's Gains While Downsizing Risk
If there is a lesson, it's this: Even though economic conditions for 2008 are expected to closely resemble those of 2007, investors should never see gold as an investment that can only rise in price. Viewed as a hedge, and purchased at the right time, gold will provide a sound addition to many investment portfolios. And if the yellow metal also manages to produce massive gains, even better.
That said, though, there are gold investments out there that combine safety and performance.
The StreetTracks Gold ETF (GLD) offers bullion-based pricing without the storage problems and liability of delivery.
Another possibility is the Prudent Global Income Fund (PSAFX). While it's not a gold investment per se, it gives you exactly what gold investors look for – protection against a falling dollar.
Shares prices of Toronto-based gold-mining company Barrick Gold Corp. (ABX) – the biggest gold producer in the world – performed about in line with gold itself during 2007. But be wary of mining companies. They face the same inflationary pressures that everybody else does. And gold bugs aren't inherently risk takers.
If you want gains most accurately – and safely – tied to gold's value, another possibility worth a look is a pooled precious metals account, where you can buy gold and silver for as low as 1% above market price, but storage and maintenance fees are lowered by spreading the cost out amongst a pool of investors.
The Next Installment of Money Morning's Outlook 2008 Series: Oil.
News and Related Story Links:
- Money Morning:
India's Gold Imports Decline For A Second Straight Month