Dueling Fools: Gold Bull

Over the past five years, returns in precious metals have left those of the stock market in the dust. In that time, gold has advanced 140% versus a gain of only 29% in the S&P 500. Gold's returns have been strong over the past 18 months as well -- the metal is up by roughly 41% during that time.

Looking beyond the recent gains, we see other reasons to be bullish about gold for the foreseeable future. First, paper currencies will continue to decline in value and continually erode returns from cash investments. Second, while gold has historically underperformed the market, the current environment has all the ingredients for continued gains in gold.

Paper money fades
Who among us does not have older relatives constantly telling us how cheap things were when they were young? As a small child, I remember turning green with envy as my father told me that candy bars "only cost a nickel" when he was a kid. Houses, cars, gasoline, oatmeal -- just about everything is nominally more expensive than it was a generation ago.

Why?

Inflation.

The driver of inflation in the U.S. is the Federal Reserve, which has its hands on the levers that affect the U.S. money supply. Under the Fed's watch, the money supply is constantly increasing. Since 1959, the earliest date for which such data is available, the M2 money supply has been growing at an average annual rate of 6.9%. The M3 money supply -- the broadest measure of total dollars in circulation -- increased at an annual rate of 7.9%. In March 2006, the Fed stopped reporting M3 and left us with sources such as Shadow Government Statistics to tell us the supply might be growing by 11%. Whatever the situation, the price of gold has held its own with the growth of the money supply, posting an average annual gain of 6.3% since 1959.

The question for investors is whether money-supply growth will continue. For the answer, we need only to look at the current massive level of U.S. debts and the unfunded liabilities of Social Security and Medicare obligations. One of the luxuries of being American is that all of this debt is denominated in dollars. If you had to pay back a few trillion dollars, which would you prefer -- a strong dollar or a weak dollar? I'm betting the big shots prefer to service the debt with weak dollars and will keep the printing presses running at full speed. Furthermore, it is not just the U.S. -- the Europeans and Asians are flooding their economies with paper money, just to keep up. The world is awash in cash, and the result will be higher prices for everything -- except stocks.

Gold goes against the grain
For investors in the stock market, gold has a wonderful attribute -- when stocks slide, gold often shines. As shown above, this has been true during the past five years, and it was true in the '70s, when gold investors made big money and stock investors faced big losses. This is why I love gold as a complement to my portfolio of stocks. Am I predicting the next bear market is imminent? Not at all, but like Rex Moore, I know it is coming. Someday, there will be another market crash, and gold will likely prove its value again, as investors seek safety in turbulent times.

Why would the stock market decline? My first bet would be the aforementioned inflation. But, just to be thorough, we could add another war, huge levels of public and private debt, a rapidly deflating housing bubble, the subprime-mortgage crisis, terrorism -- any or all of the above. I don't know. Maybe I'm just a pessimist.

Foolish bottom line
Maybe the Federal Reserve will slow down the printing presses and the dollar will become stronger. Maybe all three forces behind a market crash do not exist right now, and the current bull market will keep moving forward. However, inflation has already hit the property market and most commodities. Expensive property, oil, and corn will keep the consumer price index headed up and interest rates, in turn, on the rise. Stocks will likely deliver sluggish returns, and folks with a bit of gold in their portfolio will be well rewarded.

Best of all, never before has it been easier for individual investors to buy gold. Exchange-traded funds such as StreetTRACKS Gold Shares (NYSE: GLD  ) and iShares Comex Gold (AMEX: IAU) allow investors to purchase gold without the transaction fees and storage problems associated with coins. Each share represents ownership of one-tenth of an ounce of gold held in a bank vault, and if you own enough (100,000 and 50,000 shares, respectively) you can actually exchange your shares for gold.

You're not done with the Duel yet! Go back and read the other arguments, then vote for the winner.

Fool contributor Robert Aronen owns shares of both StreetTRACKS Gold Shares and iShares Comex Gold, but of no other stocks mentioned in this article. His CAPS portfolio is based on three simple principles -- gold and oil are going up, and housing is going down. Do you disagree? Try to beat him in CAPS, where he is currently ranked in the top 2% of more than 25,000 players. The Fool has a golden disclosure policy.


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