The Trends Favor Gold

Source:

"Shareholders of companies that find new deposits will be richly rewarded."

Strong demand for gold coins and bars has created a shortage of physical product. Exchange traded funds (ETFs) have become extremely popular. Gold ETFs now hold 45 million ounces of gold, an all-time record.

For the first time in nearly three decades, the public is looking favorably on gold as an investment. Yet gold stubbornly refuses to break through $1,000 and overtake the record price set a year ago.

Investor demand, however, is only part of the picture. The European central banks are among the largest holders, and their sales over the past decade have been a major factor in the market.

Another large holder, the International Monetary Fund (IMF), has been talking about selling some or all of its gold for years; the financial crisis may result in more of its gold on the market. Other central banks are buying, offsetting part of the European selling.

The Asian nations hold a very small portion of their reserves in gold. China, with $2 trillion, the largest foreign currency reserves of any nation, holds less than 1% in gold. There is speculation that China and other nations might increase their holdings.

A very important factor in gold is the see-saw between investor demand and jewelry demand. Investors tend to buy as the price rises and sell as the price falls. Jewelry makers do the opposite. The big swing variable and, therefore, the most important determinant in the short-term price, is investment demand.

Economists will tell you that when the price of a commodity increases, demand falls and production increases. Economic theory doesn't necessarily apply in the mining world.

The gold price has more than tripled in the past eight years, yet demand continues to rise. On the other hand, the supply of gold is falling as the price rises. Gold mine production has been falling for several years, peaked in 2002, and is projected to continue to fall.

What does all this mean to an investor?

There are many reasons to believe the gold price will go higher, perhaps a lot higher. But, not necessarily right away. Regardless of what happens to the price in the near term, the mining industry desperately needs new deposits. Shareholders of companies that find new deposits will be richly rewarded.

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