A Golden Opportunity

Got gold?

If not, it's time to at least ask yourself why you're missing out on the strongest bull market going right now. Bonds are still down big from the summer's peak. Stock flippers have finally gotten cold feet. But gold hit a seven-year high last week before pulling back modestly on profit-taking.

I'm rooting for the profit-taking to turn into a full-fledged correction blowing off some speculative steam, along the lines of the recent action in biotech and semiconductor stocks. Because once that happens, gold will be a screaming buy, instead of the reasonable one it is right now.

It takes some guts to pay up for a metal that has appreciated nearly 50% in two-and-a-half years (albeit from a historic low), especially when central-bank reserves alone would cover eight years of current global demand. And I wouldn't suggest taking the plunge if George W. Bush and Alan Greenspan hadn't adopted policies virtually guaranteed to make gold look good, at least relative to the depreciating dollar.

The Federal Reserve is bent on flooding the world with a wave of liquidity big enough to lift sluggish business investment and a tightfisted job market. The central bankers are now on record acknowledging that a little more inflation would be a good thing. Whereas the Bush administration is pursuing unabashedly inflationary fiscal and trade policies safe in the knowledge that the bill for rash budget deficits and crass protectionism will not come due until after November 2004.

Gold loves inflation, whether it's expressed in the rising prices of Chinese-made goods or via asset bubbles. Inflation is what pumped up the price of bullion to $850 an ounce in January 1980. The metal's 70% decline over the next two decades was a byproduct of the anti-inflationary zeal that's now been abandoned.

Gold is the anti-dollar, traditionally rising and falling in pretty much inverse proportion to the health of the greenback. And Washington is brimming with bipartisan determination to devalue the currency in the name of jobs and on behalf of uncompetitive Midwestern manufacturers.

As usual, the politicians have half a point. The nation is now consuming $1 for every 95 cents it earns, its record current account deficit requiring foreign-investment inflows of $1.5 billion a day, weekends and holidays included. A drastically cheaper dollar would help correct the imbalance.

But we're all paragons of fiscal rectitude next to the U.S. government, which plans to spend $1 for every 77 cents in tax receipts over the next year, if you count the $87 billion recently requested for Dubya's not-so-excellent Iraq adventure.

This sort of profligacy would be good news for gold and bad news for the dollar even if the Federal Reserve weren't in such a generous mood itself. Add in an accommodative Fed, and you begin to understand why net long interest in COMEX gold futures reached an all-time record at the start of this month. Hedge-fund managers have had their own peek at the nation's books, and know an overleveraged position when they see one.

The dollar is holding its own for now because the U.S. is growing much faster than Japan or Europe for the moment, and so can still promise better returns. But the disparity between the growth rates is about as wide as it can get. Either Europe and Japan will grow faster, or their inertia will drag the U.S. economy back down to its recent plod. And while the U.S. growth premium diminishes, the U.S. appetite for foreign cash should continue to expand.

But heavy as speculation in gold may have gotten in recent months, the bullion bulls still represent a minority opinion. That record net long position on the COMEX is worth less than $5 billion at the current gold price. The entire gold sector, generously doubling one analyst's 2001 estimate, has attracted investment inflows of maybe $400 billion, less than 5% of the value of U.S. stocks and less than 2% of the value of publicly traded dollar-denominated debt. Low interest rates and relatively high price/earnings ratios reflect confidence that the economy and the federal budget can grow out of their imbalances. A change of heart by a relatively small proportion of equity and bond investors could give gold prices a big boost.

For now, retail investors can play gold via a few dozen mutual funds or by buying shares in individual mining companies.

The buzz at the recent Denver Gold Forum (which gave off the vibe of a mining camp sitting on a particularly rich vein) was about the World Gold Council's plans to launch exchange-traded funds directly linked to the value of gold on the London and New York stock exchanges. This would make buying gold as easy as buying a stock, free investors from worrying about fund and company management, reduce investment costs and perhaps even diminish the gold sector's notorious volatility.

The idea is to give the yellow metal the wider investor base it has sorely lacked. The rest will be up to Madison Avenue. "Go for the gold." "Crisis-proof your portfolio." The possibilities are endless.

Oh, by the way, here are a few caveats every potential gold investor needs to know. An international deal limiting gold sales by European central banks expires next year, and prices could take a hit if it isn't renewed or is renewed with an uncomfortably large quota.

Also, part of the run-up in the gold prices thus far has been accomplished thanks to massive dehedging by its miners, who used to want protection from gold price movements but now want to be as closely tied to their commodity as possible. Much of this unwinding has already taken place, and will only slow further or even reverse if gold prices keep rising.

Also, I wouldn't want to be overexposed to gold the day the Federal Reserve hints at higher interest rates. Said day, fortunately, isn't expected to arrive until well into next year.

On the other hand, gold production is forecast to decline for several years to come, while the jewelry industry accounting for the bulk of global demand could revive with the rest of the economy. Also, the Chinese and Indian governments have recently made it easier for their consumers to satisfy their pent-up appetite for precious metals.

But the main reason to own gold is that the dollar is headed lower in the long run, thanks to a free-spending government and a lax Fed. If they succeed in reviving the economy, gold should easily outperform bonds. And if they fail, rest assured it will beat the returns of Cisco Systems (CSCO), Sun Microsystems (SUNW), Wal-Mart (WMT) and Krispy Kreme (KKD) combined.

The president of leading gold producer Newmont Mining (NEM) last month forecast a gold price of $450 an ounce sometime in 2004. At the time, gold was selling for $347 an ounce. But you can't buy it that cheap now.