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Wealth Building

Wealth Building Thru Gold Investing – It is All About Supply and Demand

I took me a good year and a half to get back into the groove after the pounding I took during the internet implosion of 2000. That was an extremely painful year and I was in no hurry to donate more money to Wall Street. I tried a few of the same old things from 2000 in early 2002 with little success. By late 2002, I discovered Adam Hamilton and the world of commodity stock investing.

Since I worked in high tech, I had seen first hand how tons of money was plowed into anything internet related. Engineers with Power Point presentations had gotten millions of dollars in venture capital money, while capital intensive areas such as mining were ignored. The payback on an internet investment was infinitely shorter than an investment in mining. Mining companies had to find deposits, mine and then sell it. There were environmental and political issues to overcome as well as potential labor problems. With virtually no investments going into mining, it made sense that commodity prices were in the dump.

As I learned more about commodities, I understood why most of Main Street avoided investing in this area. Investing in mining companies have too many moving parts. Not only are you concerned about the company’s fundamentals, but direction of the commodity itself plays a major factor. Gold stocks seldom go up if the gold itself is trending down. There is also political risk. Gold is found in all parts of the world and sometimes the governments play by their own rules. Every now and then, a non-mining friendly government seizes a mine after companies have invested millions in development. Unfortunately, there are many more factors affecting the price Gold. In Adam Hamilton’s latest essay, he list 10 factors affecting Gold’s price.

Many people believe that we are in the second phase of a secular bull market in gold. If that is true investment demand will trump all other drivers; which happens to be the easiest of the factors to comprehend. Basic economics state that when demand exceeds supply, prices rise. Rising prices provide incentive for producers to increase production. However, like already discussed – it takes more than a Power Point presentation to produce Gold. In other words, prices will continue to rise until demand is satisfied.

The question becomes what will cause investment demand too increase. In November 2004, GLD a gold exchanged traded fund (ETF) was listed on the New York Stock Exchange. For the first time investors could purchase gold as easily as purchasing a stock. No more trips were required to the local coin dealer. No more concerns about storage. Simply click a few buttons and you are an owner of gold. GLD has become one of the fastest growing ETFs in the United States.

Not only has GLD provided opportunities for individuals, but also for many institutions like pension funds that were prohibited from directly owning gold. For diversification purposes, it is quite useful to own asset classes that are increasing in value while other aren’t. It is well known that commodities do exactly that – they have a negative correlation to equities. So, GLD becomes an excellent way for institutions to further diversify their assets. A silver ETF was listed in May of 2006 and there is discussion of introducing a platinum ETF in 2007.

That’s all well and good, but it is the demand from Asia that will send gold to all-time highs. Asian cultures have a strong affinity for gold. One’s personal wealth is traditionally determined by how much gold is owned. Indian brides receive dowries of gold often in the form of gold jewelry or gold coins. Indian families store extra income from the harvest each year in gold jewelry. It is truly a fabric of their life.

China is on the verge of becoming the world’s next super power. As Asian investors become wealthier, their ownership of gold will increase. There are literally billions of people in China. It is true that many will not attain the standard of living as enjoyed in the US, but the demand created by hundreds of millions of Asians buying small amounts of gold will be unprecedented.

Yes, that demand will take some time to materialize, but investors in gold are quite pleased today. In 2006, GLD outperformed the S&P 500, 22.5% vs. 13.6%. My preferred vehicle Central Fund of Canada (CEF) a 55/45 mix of physical gold and silver outperformed them both, 37.2%.

I used to try to convince my friends to buy gold by talking about inflation, the decline of the dollar and geopolitics. Now I simply talk about supply and demand.

BTW, GLD was just recently listed on the Singapore Stock Exchange.