Is it time to buy gold?

With a rough economic road ahead, U.S. stock investors are nervously asking themselves: Should I stay or should I gold?

Gold has long been touted as the ultimate hedge against hard times. They don’t call it the gold standard for nothing; central banks the world over stockpile the stuff to defend the value of their currencies.

Historically, gold prices rise when currency values and interest rates fall. Gold has been on a seven-year rally that has seen it rise precipitously out of back-to-back price slumps at $255 an ounce in 1999 and 2001 to early 2008 peaks of more than $900.

Gold’s recent upward mobility, especially a 31-percent gain for 2007 followed by another 11-percent spike in the first month of 2008, has gold enthusiasts (known as gold bugs) and precious metals analysts alike watching in wonder at the commodity’s latest high-wire act.

What is commodity?

A physical substance, such as food, grains, and metals, which investors purchase, usually through what are called futures contracts.

Some say a price correction is imminent and long overdue, others maintain that gold’s next great historic run is just getting started.

The question is, should you buy gold now, even at historic highs of $900-plus an ounce?

Too high to buy?

Although it may seem counterintuitive, experts say it is definitely time to put a little bling into your portfolio.

“Yes, it is a buy right now,” says Ashraf Laidi, chief strategist for CMC Markets. “Even though gold is at an all-time high, I think you should look into at least 10 percent to 15 percent (gold) allocation. My personal portfolio was at 10 percent; it’s now at 55 percent. But I got in a long time ago.”

What is asset allocation?

An investing strategy that tries to minimize risk and maximize returns by putting money into different investment instruments.

Leo Larkin, equity metals analyst for Standard & Poor’s, admits gold continues to exceed his expectations.

“I’m surprised at just how strong it has been. Even though I think it could pull back, probably if you don’t own some, you still should,” he says. “It’s high now, but what if it’s going to go higher? I believe it will.”

Shayne McGuire, author of “Buy Gold Now,” thinks conditions are ripe to push gold beyond reasonable expectations.

“I think gold will certainly rise into the thousands, perhaps reaching $10,000,” he says.

“The last 100 years, stocks have outperformed gold perhaps 10 to 1 as an investment, so there’s no disputing that the place to be is in stocks in the long run. But there are these peculiar moments in history when I think: gold. So few people own it that just the move of people into gold will cause it to really surge. I think we’re in the second or third inning of the gold rally.”

‘A stealth bull market’

So why hasn’t there been a modern-day gold rush?

Larkin admits it puzzles him, too: “Considering how well it’s done, gold has been something of a stealth bull market because I don’t get the sense that there is any kind of public fever about it.”

Younger investors likely missed the last gold boom that occurred in January 1980, when gold shot up $400 an ounce to $850 in one month; in inflation-adjusted dollars that would top $2,000 an ounce today. Although a pullback followed, gold continued on an upward tack. Suddenly, Granddad’s Krugerrands didn’t seem quite so uncool.

For years, gold bugs were considered conspiracy-crazed, end-of-the-world survivalists; today, Republican presidential candidate Ron Paul is their standard bearer. In their view, currency is about as valuable as the paper it’s printed on.

McGuire says they have a point: “When the Federal Reserve was created, it was a rule of thumb that 40 percent of the dollars in circulation had to be backed by gold in the vault. Today, if the Fed wanted to return to that 40-percent ratio, it couldn’t do it even if it owned all the gold in the world at present prices. That’s 159,000 tons. That still wouldn’t be enough to back all of the dollars in circulation.”

To make matters a little more harrowing, central banks around the world have been dumping gold and instead backing their own currencies with U.S. dollars. McGuire says that while exact figures are unavailable, England and Australia reportedly have very little gold left in their coffers.

McGuire says two factors further reduced the supply of gold recently, helping to fuel the rally: gold production peaked in 2001, resulting in decreased inventory, and central banks, whose sale of gold previously provided about 15 percent of the gold supply, reduced their gold dumping a whopping 38 percent in 2006.

Golden opportunity

On the demand side, Laidi cites six reasons for this golden opportunity.

  1. Real interest rates (interest rates minus inflation) are down globally. Result: Gold yields a better return than stocks or bonds.
  2. The declining dollar. Gold rises when currency falls.
  3. The ETF effect. With the introduction of exchange-traded funds in 2003, investors can now buy into the gold market with the click of a mouse. What’s more, it’s less risky than investing directly in gold mining. Two of the most popular gold ETFs are StreetTracks Gold Trust (GLD) and iShares COMEX Gold Trust (IAU). “The convenience by which individual investors can get in on the gold rally is propelling the rally itself,” Laidi says.
  4. International rally. Gold is rallying worldwide, not just against the U.S. dollar but other currencies as well. Every time the Fed cuts interest rates to contend with the impact of the credit crisis, gold becomes more attractive.
  5. Increased fabrication: Emerging economies in China, India, Asia and the Middle East are boosting demand for gold jewelry.
  6. Political and economic uncertainty: When fears arise as they did post-Sept. 11, the enduring value of the world’s oldest currency takes on a new luster.

McGuire says there is something comforting in the relatively finite gold market. Although gold amounts to a scant $4.5 trillion of the $140 trillion global asset market, less than 5 percent is traded each year — “about what trades in two hours on a boring day on the New York Stock Exchange.

What is ETF?

Exchange-traded funds hold a basket of securities like mutual funds and trade like a stock.

“So as you see more and more people starting to buy gold, there really isn’t that much out there, so the price just rises because gold can’t be printed,” he says.

Larkin says market size works in gold’s favor today: “If investors decide to hedge their bets a little bit, when you consider how small gold is relative to the bond, foreign exchange and global stock markets, it wouldn’t take but just a small change in allocation for investors worldwide to push it up quite a bit.”

Gold has its detractors, of course. As a commodity, it does not produce earnings or pay dividends or coupons. Its value is set by supply and demand. You could hold gold for years without even keeping up with inflation.

What is dividend?

The portion of a company’s earnings and profits that are paid to stockholders of the company.

“A lot of very, very smart people think that gold is a loser’s game, and I respect that view because it is in so many ways,” says McGuire. “You can make an argument that gold doesn’t make any sense at all; I just think there are so many reasons why gold makes sense now.”

Larkin predicts the gold rally could last another two to three years before it levels out, with or without the long-overdue correction. “When it finally does peak, because the cost of mining it has gone up so much, it’s going to be a much higher floor,” he says, good news for long-term investors.

For gold bugs, this rally isn’t just about profit; it’s about vindication for their vision.

“It will be a reflection of people’s need for security,” says McGuire. “It’s the most underowned asset in the world, even today. I think people love momentum, and if you see gold break $1,000, more and more people will realize, ‘Hey, I don’t own any gold, I should have 5 percent or 10 percent,’ and it will just keep going. I think it’s going to go a lot higher, but I also remember the book, ‘Dow 36,000.’ You never know.”

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