The best performing major asset class for 2005 was gold. However, gold has lagged the commodities and precious metals boom and is still very cheap in relation to other commodities such as oil against which it has traditionally been benchmarked.
In fact, gold was at a 25-year low in terms of its value in barrels of oil this summer, and other metals have risen in price by a factor of several times. Therefore, don't be fooled into thinking that gold's recent rally has made gold expensive, on any rational analysis gold is very cheap, and you should always buy low and sell high.
Why is it that gold prices are only now getting back to where they stood 25 years ago? When you think of general price inflation in that period surely gold is due for a major revaluation. A university graduate in London earned perhaps $12,000 in 1980 compared with $45,000 today, yet gold prices are actually lower than in 1980.
In the investment world spotting an undervalued asset is the name of the game. Gold has also been in short supply for the past year as a physical commodity, while investors have begun to look at gold as a hedge against rising inflation due to the high oil price, and as a financial safe haven against likely problems in capital markets due to high US debt levels or even a serious outbreak of bird flu.
Zero sum investmentAnother reason to buy gold for 2006 is simply that the alternatives do not look so bright. Hedge funds have had a lousy 2005; US equities have shifted sideways; US bonds have probably peaked and higher interest rates should depress bonds; real estate is beginning to feel the impact of higher interest rates; GCC equities look massively overbought and the best real estate opportunities have gone; and so the list goes on, US and UK property are in trouble too.
Choosing a safe haven in such an uncertain outlook is really a no-brainer. Instead of gold you could opt for a US dollar deposit account, but it is difficult to know if the US dollar will rise or fall in a tougher economic environment, and perhaps owning gold that is denominated in US dollars is sufficient exposure.
Hence a simple zero-sum investment game leads you to gold as the best option for investment in 2006, which is probably going to be a year in which capital preservation is more important to worry about that capital gain. How then should you invest in gold?
How to invest in goldBuying gold bullion bars and coins is one idea, but gold is very heavy and this is not practical for larger investment amounts and not very secure either.
Thus a fund indexed to the price of gold such as GLD on the NYSE is an easy way to hold exposure to the price of the physical metal alone. For convenience you can buy and hold GLD in any online brokerage account, and sell it when you want to at the click of a button.
Secondly, the purchase of shares in the largest global gold mining companies is an excellent way of getting exposure to gold, and depending on their hedging policies gold mining company share prices tend to move upwards more quickly in value than the price of gold, so this is a leveraged investment to a degree.
The big names are well known, and easily researched on the Internet: Newmont Mining, Harmony, Gold Corp, Barrick Gold, and Placer Dome are some major gold mining companies to consider; and the least hedged of all, so that the share price moves up and down the most with the gold price is Seabridge Gold.
Thirdly, consider buying some gold futures contracts on the new Dubai Gold & Commodities Exchange. At the time of writing December 2006 futures were trading at only a 6% premium over the spot price of gold, so if you think that is pessimistic then buy these contracts through a local brokerage.
For 2006 gold investors should consider physical gold or a gold index first, and then add a few major gold mining companies and DGCX gold futures contracts. But for real performance the junior gold exploration stocks should be considered, and these smaller capitalization firms will be reviewed in Part Two of this article.
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