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Find Safety Amid Crisis
with Gold
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Published:
December 22, 2008
Located in modern-day Turkey, Lydia was one of the wealthiest
kingdoms of the ancient world. In fact, the region was so
prosperous its King has given his name to a common expression:
"rich as Croesus."
The obvious question is how ancient Lydians managed to become so
rich. Lydians were known as savvy merchants but trade was not
their greatest accomplishment. Rather, Lydia's greatest
invention was coins. More specifically, sometime around 700 BC,
merchants in the region became the first traders to strike coins
made roughly 66% of gold and 33% of silver.
This was the first time in history that physical gold was used
as money. Within a hundred and fifty years, around the time of
King Croesus, Lydia had amassed a huge store of gold; the coins
proved popular as a medium of exchange. Most subsequent great
empires including Greece and Rome adopted similar coins as a
store of wealth and a convenient way for traders to pay one
another.
Of course, gold's history as a store of value is even older than
that. For at least the past 4,000 years, traders have accorded
value to gold jewelry and ingots. In fact, gold was one of the
first metals humans ever discovered -- the shiny metal is found
naturally occurring in streams in many parts of the world.
Most modern coins are no longer made of gold and other precious
metals; however, that doesn't mean that gold has given up its
status as a convenient store of wealth. In fact, quite the
contrary.
Most modern currencies are what is known as fiat money -- the
currency is not backed by any physical commodity but by the
faith and credit of the country that issues it. Therefore,
currencies backed by irresponsible governments can and have lost
money.
Classic examples would include the German currency during the
hyperinflation of the inter-war years and the Roman denarius in
ancient times. More recently, the value of the Zimbabwe dollar
has collapsed this year as inflation in Zimbabwe has topped 300
million percent per month. In mid-October, the U.S. dollar
fetched about 1 million Zimbabwe dollars; today, the country's
newly introduced 200 million dollar note is worth less than $10.
In each of these cases, as fiat currency has lost value, traders
have used gold as an alternative currency of choice.
 But
even in more responsible countries, gold has maintained its
value -- and continued to gain against the dollar as our chart
shows.
And the phenomenon is not recent. The U.S. dollar has lost
approximately -50% of its purchasing power since 1981. In that
same time, gold retained almost all of its purchasing power.
This is despite the fact that the period since 1981 has been
widely considered a period of relatively low inflation.
With U.S. inflation declining and the dollar relatively strong,
it's tempting to assume that gold prices must be weak today.
Certainly, gold prices, like most other commodities, have
weakened since mid-year. But gold has remained remarkably
resilient as compared to other commodities such as copper and
oil. Since July 1, for example, gold prices have fallen -11%
while oil is off -67% and copper is down -62%.
One major reason for this outperformance -- gold is seen as a
hedge against uncertainty and crisis. Investors tend to buy gold
when the economic picture is uncertain. According to the World
Gold Council, in the third quarter of this year investment
demand for gold -- a measure of how much gold is being purchased
as an investment rather than for jewelry or industrial uses --
soared to record levels of $32 billion.
In terms of tonnage, demand in the third quarter of 2008 was up
+18% above year-ago levels. Early indications are that
investment demand has continued to rise in the fourth quarter.
And at the retail level, due to extremely high demand there are
widespread reports of shortages of certain types of gold coin
and gold bars.
Some investors believe that efforts by the U.S. government to
restore order to the financial system will ultimately mean a
reacceleration of inflation and renewed weakness in the dollar.
If that's true gold should assume its traditional role as a
store of value. Alternatively, if the financial crisis drags on
for a while longer, investors should continue to invest in gold
as a hedge against instability. Either way, gold looks to be on
solid footing at current prices.
But even better value than the commodity itself are companies
involved in mining gold. The Philadelphia Gold and Silver Index,
an index of firms in the gold mining industry has fared far
worse than gold itself since mid-year. That index is off more
than -45% compared to far less than that for the yellow metal.
This underperformance makes little fundamental sense. Many of
the best-positioned gold mining firms can mine gold at a cost of
$300 per ounce or less. With gold currently over $800 per ounce,
these miners are extraordinarily profitable. Most likely, gold
mining shares have been hit by selling in the broader stock
market averages; in bear markets, investors tend to sell their
stocks en masse and with little regard for stock selection.
With these points in mind,
Market Advisor editor Paul
Tracy and his staff recently
profiled two gold mining
stocks that look particularly well-placed to benefit from
current gold prices. To learn more about these golden
opportunities and to learn more
about the Market Advisor
newsletter,
please visit this link. |
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