COMMENT
The Future For Gold

By David Kuo (TMFDragon)
February 1, 2006

Last week I caught up with an old friend who also happens to be a professional gold trader. Not surprisingly, our natter over old times quickly moved onto the subject of the recent rise in the price of gold.

As expected he was very upbeat about the prospects for the yellow metal. In fact, he reckons that gold could climb further from its current price of $570 an ounce. But I wanted to know why he thought gold prices could carry on rising.

He quickly sketched some charts on the back of a paper serviette detailing the recent movement of the price of gold. The graph was also embellished with some dotted lines, which he called support levels. He claimed that these showed that gold may test yet higher levels. But I was unhappy to accept that gold will climb simply because of some judiciously chosen Biro marks on a paper napkin.

I was more interested to know about supply and demand. As it turns out, apart from the gold's main use in jewellery making, it has been a core holding for many dedicated gold bugs. (Around 37,000 tonnes of gold is held for investment purposes.) These hardcore gold fans hoard the metal as a means of diversifying the risk in their portfolio. Many of these investors subscribe to the view that gold is negatively correlated to the stock market. In other words, the price of gold and the stock markets are supposed to move in opposite directions.

Mind you, there has been an increase in the number of new gold investors in the last couple of years. These investors have warmed to the metal because gold is seen as a good investment during stormy economic times. Additionally, rising oil prices and a weak dollar, which can be a trigger for inflation, may tempt yet more investors to turn to gold. So together, the hoarders and new gold bugs have helped to push up gold prices, which in turn have attracted more speculators who just want to capitalise on the price rise.

So there we have it. Gold is rising in price because demand and supply are out of sync, with the former exceeding the latter. It is estimated that 2,500 tonnes of gold is mined each year, and annual demand is around 3,500 tonnes. But imbalances between supply and demand occur in other commodities, too. For instance, sugar hit a 25-year high last week because of demand from the booming economies of India and China. Additionally sugar has found a new use as a replacement for petrol in cars.

Before you leap on the gold bandwagon though, here is something to consider first. Except for the last four years, gold has been on the slide since reaching its all-time peak of $850 an ounce in 1980. Of course, this may suggest that at current prices gold may still have some way to rise.

But it's also worth remembering that unlike other commodities the industrial uses of gold are limited. Consequently, it pays to tread carefully when investing in a metal whose demand is driven not so much by its commercial applications but instead by the whims of human nature. Additionally, it's worth bearing in mind that some 44,000 tonnes of gold is held by various central banks, which they occasionally threaten to sell!

> Four Ways To Invest In Gold | Gold: A Poor Long-Term Investment