Dreaming of a Gold Christmas?

Since the beginning of time
For thousands of years, gold has been used as a form of money or a display of wealth in the form of jewelry. Many Roman coins were made from gold. Egyptian kings were buried with fantastic gold ornaments. In modern times, the U.S. economy grew into the most powerful on Earth with a dollar backed by gold. With such a history, gold is a gift much more significant than writing your nephew a check with a note that says, Don't blow it all on video games.

What is it about gold that makes it endure through the millennia? It is beautiful (i.e. bling), it does not tarnish or diminish with age, and it is rare. These are only a few of its attributes. Gold, how do I love thee? Let me count the ways.

Gold is rare
While many commodities have been experiencing bull markets for the past few years, most other rocks and minerals are plentiful. At a given price, the supply of copper, coal, or iron ore can be increased. With gold, higher prices certainly lead to increased mining activity, but those efforts may or may not yield additional production. Looking at global production over the past 10 years shows essentially no production increase, even in the past several years of rising gold prices.

Year

Gold Production (Metric Tons)

1996

2,290

1997

2,450

1998

2,500

1999

2,570

2000

2,570

2001

2,560

2002

2,550

2003

2,550

2004

2,430

2005

2,450

Source: U.S. Geological Survey.

Annual production of gold tells only part of the story, because gold is not consumed the way other commodities are. It is not burned to make power as coal is, or converted to ethanol as corn is. Central banks and ETFs keep it in vaults. Private parties keep their jewelry and then go down to the pawn shop to hock it when times get rough. It is estimated that of all the gold ever mined, 85% of it remains, and it's estimated at 129,000 tons. Of that amount, 33,000 tons are held in central banks, and 96,000 tons are in jewelry. It is precisely because gold does not go away that it has lasting appeal as money. Given the numbers above, it is a money supply that only grows at 2% per year and thus maintains its value.

Demand is rising
Demand for gold is driven mostly by the jewelry market, central bank reserves, and investments. Consider jewelry. As the number of wealthy people in the world increases, demand for gold jewelry is predicted to rise. Central banks, on the other hand, were net sellers of gold from 1995 to 2001 -- and here is where we note the irony of the best financial minds selling gold when it was at a 30-year low in price. Since 2001, there has been speculation about Russia and China increasing their central-bank gold reserves, but limited data is available. On the investment front, ETFs including StreetTRACKS Gold Shares (NYSE: GLD  ) and iShares COMEX Gold (AMEX: IAU  ) have made investing in gold much more accessible to individual investor. These funds and similar products available in foreign markets have helped increase demand for investment gold.

Gold protects
In a peaceful, stable, non-inflationary world, gold would be valuable, but it would likely underperform as an investment class. However, gold prices rise in times of war, unpredictability, and inflation. In the past five years, the world seems to have become less peaceful, with instability rising in key energy-producing regions. Furthermore, inflation continues to raise its ugly head, as evidenced yesterday, when the core producer price index for November was reported at 1.3% -- the highest reading since 1980.

Of course, no one can predict the future, and no one knows whether war, instability, or inflation will increase or decrease. Study after study has shown that a well-chosen portfolio of stocks has always been your best bet for long-term capital appreciation. Many of those same studies also show that gold returns are not correlated to stock-market performance. Therefore, a 5%-10% position in gold in your holdings may soften the blow of the next bear market.

Foolish bottom line
When thinking of the ones you love, give a gift that will love them back. Gold will last far beyond our time on Earth and will remain beautiful. A thousand years from now, people will likely still adorn themselves with gold. In the coming decades, the supply of gold will rise only slowly, and that will keep the metal precious. Demand will likely rise as billions of people increase their purchasing power and barriers to investing in gold are eliminated. Finally, the next time the stock market tumbles, a position in gold might just help you sleep through the cold winter nights.

Foolanthropy is celebrating its 10th year! To learn more about our five Foolish charities or to make a donation, visit www.foolanthropy.com.

Learn more about investing in precious metals via exchange-traded funds by visiting our ETF Center.

Fool contributor Robert Aronen owns shares of both StreetTRACKS Gold Shares and iShares Comex Gold. The Fool has a disclosure policy.


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