Worth Its Weight? Investors Seized by Gold Fever amid Economy Worries

Concerns over the financial markets and the global economy are driving the price of gold to historic heights. But is all that glitters really worth investing in?

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Many would rather put their money into gold bars than trust the financial markets -- but is gold a good long-term investment?
DPA

Many would rather put their money into gold bars than trust the financial markets -- but is gold a good long-term investment?

Deep beneath London's streets lies a treasure greater than anything that even the Bank of England possesses: Thousands of gold ingots, each weighing in at more than 12 kilograms (26 pounds). The ingots, neatly arranged on wooden pallets and stacked high to the ceiling, glow softly in the dim neon light of the vault. And every week a forklift adds new stacks of ingots to the existing inventory.

Financial services provider StreetTracks Gold Shares uses the heavily secured and guarded vaults to store unimaginable quantities of the precious metal for its customers. The vaults already contain more than 641 tons of gold, with a market value, at today's prices, of more than $18 billion (€12 billion).

Gold Shares is a publicly traded fund with a unique business model: Investors buy shares in the fund and, in return for a fee, the company turns their invested cash into real gold. It's a lucrative business for Gold Shares, because most banks stopped dealing in precious metals with private customers long ago.

These financial products are called exchange traded funds. The gold-based funds were introduced more than three years ago and have recently seen a massive influx of investor cash. In the third quarter of 2007, the demand for the funds skyrocketed by 617 percent over the same period in the previous year. It was a phenomenal increase, especially coming during those weeks in which investor confidence was shaken by signs of a looming US financial crisis.

Now that images of long lines in front of British bank branches have circled the globe and government-run German banks like SachsenLB have run into difficulties, investors have been thrown into an even deeper state of uncertainty. Amid growing fears that the US dollar will continue to lose value and that consumer prices, especially for energy, will keep on rising, pessimists are predicting a recession with potentially devastating consequences for the entire global economy.

Worried investors have fled to the relative safety of a form of payment that inspired confidence in the Egyptians as far back as 5,000 years ago, and that has since been seen as the embodiment of stabile prosperity and eternal wealth. Currencies come and go, but gold is eternal.

The metal's allure is still as powerful as ever. Since the beginning of the credit crisis last summer, the gold business has grown considerably, says Robert Hartmann, the managing director of Pro Aurum, a German company that deals in precious metals. The average customer buys gold coins or ingots worth €15,000 -- if they are even available, that is. "Nowadays, when someone wants to buy 20,000 Krugerrand (a South African gold bullion coin), it takes me two days to get it," says Hartmann. "It's a tight market."

This almost unprecedented demand for gold has greatly increased its value. Last Friday the price of a troy ounce (31.1 grams) reached the $900 threshold for the first time ever, an almost 50 percent increase over the price of gold a year ago. The price climbed to a record high of $914 on Monday -- before slipping back to $881.25 on Wednesday, however.

The last time the price of gold was almost as high was in January 1980 -- but only for a day. After that, it went into a decline for years. But this time the trend appears to be more sustained.

The 1980 record price is even more impressive when inflation is adjusted for.
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The 1980 record price is even more impressive when inflation is adjusted for.

Eugen Weinberg, an expert at German bank Commerzbank, says there is room for the gold price to rise even further. According to Weinberg, the 1980 record price of $871, adjusted for inflation, would translate into a current price of $2,384 an ounce (see graph). In other words, the old all-time high would be "well above the current level," he says.

There are several factors that support Weinberg's view. The worldwide supply of newly mined gold is stagnating at 2,500 tons a year. The old mines, especially in South Africa, a traditional gold-mining center, are largely depleted. New reserves often prove to be less abundant and are both difficult and costly to exploit.

For the Canadian Barrick Gold Corporation, the world's leading gold mining company, the so-called cash costs -- that is, the costs of exploration and development -- have increased from $177 to $370 per ounce today. Meanwhile, global demand for the precious metal is growing. The new middle class in emerging economies is especially hungry for gold. India has always been the world's largest buyer. At any respectable Indian wedding, it has always been customary for the bride to be festooned with gold rings, chains and bracelets.

Like Indian brides, wealthy Russians are fond of adorning themselves with the shiny metal. The demand for gold in Russia increased by close to 25 percent in the third quarter of 2007, compared to the same period in the previous year.

The Persian Gulf region's oil billionaires have also begun investing more of their wealth in crisis-proof assets. All of this helps to boost the price of gold.

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