Financial markets are often credited with predictive abilities, and in 2003 two very separate markets accurately anticipated the current economic climate.
In early April, the stock market began predicting a powerful economic recovery, as the Dow rose 27% through the end of the year, riding companies like Intel (NASDAQ:INTC), Home Depot (NYSE:HD), and Citigroup (NYSE:C). At the same time, precious metals were predicting inflation, with gold up 30%. The Gold Bugs Index (AMEX:HUI) climbed an incredible 97.3%, riding huge gains from relatively unknown mining companies like Bema Gold (AMEX:BGO).
Both markets were proven correct. Economic growth exploded in the third quarter of 2003, with an 8.2% jump in gross domestic product. Inflation (as measured by the Consumer Price Index) was benign through 2003, rising only 1.9%, before exploding at an annualized 5.5% through May 2004. To put it in perspective, at 5.5% annual inflation, prices would double every 13 years.
"Find the trend whose premise is false, and bet against it." Those words of wisdom are credited to George Soros. The reciprocal of that idea, of course, is to find the true trend and put your money on it. For 20 years, the U.S. has been in a low inflation environment, averaging a 3% annual increase in the CPI. The question for long-term investors: Are this year's inflation numbers an aberration, or the beginning of a new trend?
There are a number of reasons to fear the inflation monster: record personal and public debt levels, global economic imbalances, and huge government deficits, just to name a few. Gold, as the anti-dollar, is a classic hedge against inflation.
Short of stashing gold bars in your basement, there are a number of options for getting exposure to the gold market, including futures if you're a sophisticated investor. For the unwashed, like me, the stock market offers more accessible gold-based investments. Gold mining stocks, personified by Newmont Mining (NYSE:NEM), provide the opportunity to place a leveraged bet on gold price movements, as earnings at these companies rise (and fall) exponentially with the gold market. However, these companies also contain downside operational risk unrelated to the price of gold. Central Fund of Canada (AMEX:CEF), a bullion bank, is a less risky way to own "paper gold."
Long term, betting against the U.S. economy is a fool's wager, but it never hurts to have some safety just in case. After all, just because it's sunny out today doesn't mean you shouldn't own an umbrella.
Fool contributor Chris Mallon owns shares of Home Depot, Newmont Mining, and Central Fund of Canada through his private investment partnership.
