Model Portfolio timbo56:SSOF1

Must we enumerate everything? I used to eat at the Panda Inn in West LA, where they had a delicious dish called, "Three Ingredient Tastes." When I saw that I thought, "The numbered list is a pretty strong element in Chinese culture." But, then again, it is western culture that originated such famous enumerations as the Ten Commandments and the Seven Deadly Sins. So I guess the numbered list is a cultural constant.

Not to rebel against a universal element of culture, I will now discuss the Three Ingredient Tastes of Gold Demand. The first is growing world wealth. This is a little bit like bread dough rising. It does not change much, from one day or even week or even month to the next. But it is steadily increasing. The growing economies of China, India, Brazil, Russia and Vietnam all have increasing gold purchasing power (measured in dollars-worth of gold), but it's not much different from what it was a month ago or even six months ago. Fast-forward 30 years, however, and the size of the Chinese economy is likely to be much larger than that of the United States, with India, perhaps, not that far behind. This will lead to a tremendous growth in gold prices over the next 30 years. But it does not mean that the price of gold should be higher this month than last month, because the size of these economies has not changed very much in a single month.

Next, there is sensible investment demand for gold. This is affected by things like interest rates and the consumer price index. This tends to increase when inflation figures are high (or interest rates are low), but falls back down a little if inflation numbers read lower or interest rates tick up. It's a little unpredictable, like a faucet being turned on and off by an invisible hand (credit to Adam Smith).

Finally, there is the demand for gold caused by an increase in the price of gold, or short term speculative demand. Yes, some people will buy gold for no other reason than a perception that the price of gold is "going up." This exaggerates the movements in the price of gold, because this group of buyers also tends to sell very quickly (frequently automatically) if there is much of a drop in the price of gold.

So, how do we play the gold market. First, don't be left out. It is certainly true that for those investors who look for productive resources, such as car plants, to invest in, gold looks to be a nonstarter. Gold is not productive. For the most part it just sits there. But productive resources, by and large, are not intrinsically rare. More car plants can be built. More retail outlets can be built. More soap factories can be built. And, more restaurants can be built. Intrinsic rareness is an extremely good (and rare) quality for an investment. It makes up for the fact that a bar of gold sitting in a vault is not productive.

And gold does perform an economic function, in the sense that it is a store-of-value. The value of this function changes dramatically with perceived need. If the dollar is a good store-of-value, then there is little need for gold. But the dollar's role as a store-of-value is increasingly coming into question. If the dollar has stopped acting as a good store-of-value, and it sure has not been very good over these last few years if you are someone who travels to Europe, then the need for another will become increasingly apparent. The precious metals are far too easily dismissed by the mainstream investing community. They are fungible, dividable and rare like nothing else. They are rare by nature, whereas a million dollars is rare as a human construct. As such, the rarity of a million dollars is far more vulnerable to the shifting tides of human affairs than is the rarity of 1,100 troy oz of gold (about a million dollars worth right now). Everyone should own some gold. This is especially true today, as the huge U.S. trade deficit continues to, and will continue to, exert downward pressure on the dollar and as petroleum scarcity causes the price of petroleum to rise dramatically.

My strategy is to slowly buy in the troughs. The dough of the world economy is rising, little at a time, and it will by itself boost the price of gold over time. It is not something that can be seen on a daily basis. What can be seen on a daily basis is the change in investment demand for gold, and most particularly the short term speculative demand. When those set in, it is probably good to wait awhile and ride the wave, but then start getting out. That is a tough decision to make, but if you get out a little at a time, just as you got in a little at a time, you are likely to have a good ride on that wave of speculative demand, and still not be wiped out when it comes crashing down.

I think the next wave is going to be a doozy.