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A quick look at the price history of Gold shows it is up
over 260% over the past ten years. It’s certainly been
a good investment over that period of time. In
comparison the stock market has been down. The
S&P 500 is down 26%. The Dow is down 4% over
that period.  Of course, we are concerned with where
these indices will go in the future.

Why has Gold taken off in the past ten years? The
most likely explanation for this growth of gold is the
acceleration of the expansion of the money supply
over this period, and the decline in value of the US
dollar. Over time, Gold can be a good hedge against
the US dollar and other currencies.  Investors use gold
as a hedge against the dollar and inflation.  

Some analysts point out that the stock market, as
measured in gold, is down 70% over the past ten
years. Effectively this is measuring the stock market
US dollars, less the loss off purchasing power relative
to gold over this period.

However, we’ve seen these run-ups in Gold before,
under high inflation periods, only to have Gold prices
recede again for years. Moreover, there have been
significant up-ticks in inflation at other times, and Gold
hasn’t risen. Gold has not consistently been a good
investment over the past 35 years. In fact, except for
another dramatic run-up from 1976 to 1980, and to a
lesser extent in the mid 80’s, it has mostly been down
over the past 40 years. In January 1975, Gold was at
$190 an ounce. This was during the oil shock, with
inflation increasing. It peaked in 1979 at $750 an
ounce. Towards the end of 1982 it was back down to
$350. (See chart below).      

Some will say that in the 80’s inflation was brought
under control and therefore Gold was not being used
as a hedge as much. But the dollar was systematically
devalued in the 80’s in an attempt to reduce the US
trade deficit, and Gold never got close to its previous
high during this period.  Even during the stock market
crash in 1987, Gold was only around  $400 dollars an
ounce.  Gold did not reach its former peak of $750
again until the beginning of 2007.  Those holding Gold
as a hedge against stock market bubbles or other to
show for it, as Gold lost 40% of it’s value.  

So, is will it be different this time around? It may be.
The money supply has increased dramatically through
2008 and 2009. Although in 2010 growth has slowed
once again. The US and many other countries have
record government spending deficits. Yet inflation is
very low. Is all this excess liquidity going to result in
hyperinflation in years to come? Possibly. Yet we saw
how fast Gold lost its value in 1979/80 when it
appeared less inflationary policies were about to be
followed by the new government.

Even if higher inflation is coming, doesn’t the current
price of Gold, at close to $1,200, already have this
expectation built into it? And therefore has little upside
unless even larger crisis present themselves?  

No one knows whether this is a new higher permanent
level for Gold, or if it will go higher. But the market
itself certainly has the appearance of bubble market,
where the latest price rises seem to be as much
about a market building on the expectation that it will
always rise, rather than fundamental factors. Also, don’
t forget that Gold has only in recent years been widely
traded on ETFs and bought and sold as an
investment class, leaving it more vulnerable to sheer
momentum price movements, whether up or down.

Given this, I believe that it’s time to reduce one’s
exposure to Gold. Not that it should be eliminated
from one’s portfolio, but it should be reduced from
previous levels to further limit the relative downside
risk here.


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