Tuesday, September 30, 2008

Looking for A Gold Lining Behind Dark Market Clouds

The gold market has been an interesting one of late. Even as other precious metals have swooned along with commodities as a whole, gold has managed to hold its own. When commodities were in favor during a period of inflation concerns, gold managed to benefit. Now, with economic weakness and the need for extensive government intervention to save the financial system, gold benefits from concerns over the value of the U.S. dollar.

The chart above shows the SPDR Gold Trust ETF (GLD) from 2006 to the present (blue line). The pink line is a 50-day moving average of volume in GLD. GLD is an interesting vehicle in that it is a way for the non-futures trading investment public to benefit from movements in the metal without the requirements of physical ownership and storage. What we see is that trader and investor interest in GLD has skyrocketed since the summer of 2007, which is also when we saw stocks make their bull market highs.

One interesting dynamic that could play into a longer-term bullish picture for gold is the fact that many countries hold very little of their reserves in the form of gold. The United States, for example, holds about 78% of its reserves as gold; Germany holds 66%. Japan, on the other hand, holds only 2% of its reserves as gold; China limits gold to 1% of reserves; India, 3%; Russia, 2%; Brazil 1%; and South Korea just .2%. So, if these countries aren't holding gold, how are they storing their reserves? Many of them are heavily weighted toward U.S. Treasury instruments. Should these countries decide to aggressively diversify their reserves out of concerns for the U.S. dollar, gold--and the shares of gold mining firms--could be primary beneficiaries.