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Portfolio > ETFs > Broad Market

Gold's Renaissance

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It’s funny, but the late-night commercials that used to push food dehydrators and Ginsu knife sets are now touting gold as an investment vehicle. And while some may pass it off as a short-lived investing fad that will end badly, there’s no doubting the growing importance of gold as an asset class.

Since 2001, the price of gold has quadrupled.

Contributing factors to gold’s strength include a weak U.S. dollar, falling consumer confidence and sputtering global stock markets. In other words, the conditions for more gains in gold seem ripe.

No wonder this has brought renewed interest from investors and advisors about investing in gold.

The World Gold Council was formed in 1987 by the world’s leading gold mining companies with the aim of stimulating the demand for gold.

George Milling-Stanley is based in the council’s New York office. In 2002 he became a member of the team that developed Street Tracks Gold Shares (GLD), the gold exchange-traded fund (ETF) that was launched on the New York Stock Exchange in November 2004.

Before joining the council in 1996, Mr. Milling-Stanley worked for six years on the precious-metals trading desk of Lehman Brothers, the New York-based investment bank. His responsibilities included the development of customer business and the firm’s research and analysis of the metals markets.

He visited with Research to discuss the reemergence of investing in gold.

Research: Why is gold an important asset class?There are five main reasons why gold is an important asset class:

First, returns on gold are not correlated with returns on other investment assets, so gold provides very effective diversification as a component of a balanced portfolio. This is particularly true at times when equities are seriously under-performing — and that is important because it is during such periods that many markets tend to go into freefall at the same time. In general, markets under stress tend to behave more like each other, to become increasingly synchronous. Gold does not follow that pattern.

Second, another important characteristic of gold is its relatively low volatility. This is an aspect of gold that surprises a lot of people, who think of gold as a risky asset. In fact, over the long run the gold price is actually less volatile than the S&P 500, for example. Now, a blue chip stock market index is generally less volatile than the equity shares that comprise it, so that really is saying something significant about gold. There is another feature, and this is something that gold has in common with other commodities. The gold price tends to become more volatile when it is rising, whereas with equities the reverse is more often true. Price volatility for gold and commodities in general contains a different message from high volatility in the equity markets, where it typically signals a decline.

Third, gold is an effective hedge against a decline in the dollar. When the dollar falls in value, typically the gold price rises. The response is not always immediate, but history teaches us that this is what happens every time, even if on occasion we have to wait a little. In fact, this “inverse correlation,” as economists call it, predates the existence of the U.S. dollar. Over history, the gold price has always been inversely correlated with whatever the leading currency of the world happened to be. For several hundred years, that currency was the pound sterling. In more recent times, the U.S. dollar has been the world’s top currency. In future, it might be something different — perhaps the Chinese renminbi, the Indian rupee or something no one has even thought of yet. But whatever the next leading currency in the world is, I know one thing for sure — the gold price will be inversely correlated with it.

Fourth, gold has also proved itself to be an effective hedge against inflation over the long run. The world finally gave up on using gold as the benchmark against which all national currencies were measured in 1968, and the price of gold was allowed to float freely and find its own level in the world markets. Since that time, gold has maintained its purchasing power. In fact, gold has an even longer track record in this respect. A recent study that is available on the World Gold Council website at looked at the relationship between gold and inflation right back to the 18th century. The study found that over that period, a 1 percent increase in the general U.S. price level led to a 1 percent increase in the price of gold.

Lastly, gold also has a very long track record as an effective safe haven in times of geopolitical or economic disruption. Last year’s rise in the gold price was strongly influenced by the behavior of investors. They bought gold as a means of protecting their portfolios from the sharp fall in equity markets that occurred as the credit crisis unfolded.

During the first big downturn in equity markets between mid-July and mid-August, gold did not do especially well in absolute terms; it was more or less flat. However, it did well in relative terms if you consider that equities fell by 9 percent over the same period. During the next downward leg in October and November, gold outperformed in both relative and absolute terms, rising by 12 percent as equities fell by 10 percent.

Gold recently broke all-time highs, the $1,000 per ounce mark. Is it overvalued?My five key price drivers over the past six years are as follows:(1) Healthy internal market dynamics, with stable supply and rising demand. (2) A long-term secular decline in the value of the American dollar. (3) Growing fears over a possible future rise in inflation. (4) The equity markets have spent the past six or seven years recovering to where they were in 2000. They achieved those levels last year, and then the subprime lending crisis knocked the steam out of the recovery. (5) And finally, I don’t think anyone could argue with the fact that geopolitical tensions are worse now than they were in the early months of 2001.

The internal dynamics of the gold market look increasingly promising, with little chance of any increase in gold mine production, and continued rising demand even in the face of higher prices.

Most experts, including the International Monetary Fund and the Bank for International Settlements, believe the U.S. dollar is still overvalued and will continue to decline. Ben Bernanke, chairman of the Federal Reserve, continues to be concerned about the potential for a rise in inflation, and so do many of the investors I talk to.

In times like these, a little bit of gold is a good thing to hold.

How many similarities do you see between now and 1980, when gold peaked?On the issue of similarities, perhaps the most striking is the fact that there were many different factors underlying the rise in the gold price on both occasions. I have already outlined the five reasons gold has quadrupled since 2001. In the late 1970s, I would point to the following factors:

No. 1 reason: It had been illegal for American citizens to own gold as an investment for 40 years until the mid-1970s, and there was enormous pent-up demand.

Other reasons include the following:o The Soviet Union invasion of Afghanistan.o Iran and Iraq sounding increasingly warlike against one another.o Crude oil prices at all-time highs around $40 per barrel. o U.S. inflation in double digits.o The U.S. stock market had risen for an unprecedented period, and the U.S. economy had also grown for a very long time. All the economic signals were that these exceptionally good times were about to come to an end.o President Carter widely perceived as a weak president.

On differences, I would point out that in 1980, the price of an ounce of gold rose to more than 20 times the price of a barrel of oil at $850 versus $40.00. Today, gold is only 10 times the price of a barrel of crude.

What are the advantages of investing in gold directly instead of gold equities?I tell investors that there is probably no bad way to gain exposure to gold, but that the particular method chosen will depend on an investor’s specific requirements.

Research that the World Gold Council carried out from the year 2000 onward indicated that accessibility, the perception that investing in gold was cumbersome, costly and complicated, was the main deterrent for those investors we surveyed who had no exposure to gold. Therefore, the exchange-traded fund structure seemed to make sense for many.

How much of an impact have ETFs had on gold?There is no doubt that the introduction of gold ETFs less than five years ago has been an important element in the unusually favorable background that has enabled the gold price to rise fourfold since 2001. But it would be a mistake to believe that the existence of ETFs has been solely responsible for the price rise, as some have suggested.

For one thing, the gold price started to rise from its floor of around $250 an ounce back in April of 2001; that means the bull market had been running for two years before the launch of the first gold ETF, and for almost four years before anyone felt the impact of the market leader GLD on the New York Stock Exchange.

Perhaps more importantly, all the gold ETFs currently in existence have accumulated a total of around 900 tonnes [metric tons] of gold. Total gold demand in the five years since the launch of the first ETF has been just shy of 20,000 tonnes. That means gold ETFs have accounted for only around 4 percent of total demand since their inception. The ETF tail is certainly not wagging the gold market dog.

Based upon your data, who’s been the biggest accumulators of gold?The World Gold Council and State Street Global Advisors, the marketing agent we appointed for GLD, focused our efforts on investors who had no existing exposure to gold at all. We believe we have been successful in introducing the benefits of gold to a whole new universe of investors. 13F filings with the SEC tell us that individuals hold 70 percent or more of GLD.

Besides jewelry, what sort of other practical uses does gold have?Since 2001, demand and supply fundamentals have become increasingly positive from a price perspective.

On the demand side, the single biggest element is jewelry, accounting for 69 percent on average every year for the past five years. Investment demand has accounted for a further 19 percent. The balance is made up of demand from industry, with gold used in everything from mobile phones to electronic circuit boards and increasingly as a catalyst in industrial processes. That accounts for around 12 percent of demand each year. For more information on industrial demand, I strongly recommend a visit to, where you will find a wealth of exciting information.

Ron DeLegge is the San Diego-based editor of


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