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For five millennia, gold has stood for money and maintained its purchasing power over time. Gold, above all else, is an accepted standard of value that seldom depreciates. In fact, an ounce of gold has maintained the approximate same value since

pax romana


An ounce of gold has always been able to purchase fine set of clothes. If you look at what an ounce of gold bought 100 years ago, it bought a nice set of clothes. Today $880 -- the current price of an ounce of gold -- still buys a fine set of clothes.

Given the volatile market, gold and its consistency in value is a reassuring investment. Gold is in about the fifth inning of a bullish cycle. The good news is that the gold market hasn't reached its full appreciation. You still have time to catch some upside and insulate your net worth.

Before analyzing the gold market, let's take a quick look at where we are in the cycle. In broad terms, tangible and financial assets oscillate in 20-year cycles of outperformance and underperformance. It's always wise to overweight investments in the asset classes in secular bull markets. Tangible assets have been in a secular bull market for the last decade. Despite this year's horrific declines, the bull market in gold remains intact.

With stocks falling to and past reasonable levels in the shadow of the credit crisis and impending global recession, the best bull market around remains precious metals. Gold and other precious metals are tangible assets, similar to real estate, commodities, precious metals, gems and collectibles. Financial assets are IOUs, either debt (bonds) or ownership interests (equity).

I believe that bonds and equities will continue to deliver below average returns over the next couple of years and therefore, most investors should keep some of their net worth in gold. Based on the patterns of historical cycles, I won't be surprised if gold climbs to $2,000, $4,000, or even $5,000 per ounce in the decade ahead.

Consider adding gold to your portfolio. First, in a turbulent market like this one, you want to diversify away from financial assets. And while diversification can be elusive in market crashes, if you have been in cash and gold this year, you wouldn't have lost any money at all -- gold is up 4% year to date and T-bills have returned approximately 1% year to date.

The theory of diversification is that you always want some of your assets moving in the opposite direction of your other assets. Over the last 100 years, gold has been lowly or negatively correlated to the dollar, stocks, and bonds. As such, it's pretty likely to do well, when stocks and bonds do poorly. And besides treasury bonds -- the last asset class still in a bubble -- bonds have clearly entered their own bear market.

Now, let's examine the gold market. You can see in the following graph how gold has outperformed once stocks stopped performing in 2000.

Gold vs. the Dow Jones (1980-2008)

Click here for larger image.

The gold bear market began in 1980 after the Hunt brothers failed in their attempt to corner the silver market. Gold reached $850 an ounce briefly while silver touched $50 an ounce. In 1983, gold fell solidly below $500 and investors began to abandon it as an asset class.

The bear didn't release its grip on precious metals until late 2001. Bear markets end when the asset in question is thoroughly despised. Like the "death of equities" proclamation by

Business Week

on its August 1979 cover, gold suffered a similar eulogy in 1999-2001, while the great bull market in stocks took its last gasps of air.

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Just as equities were left for permanent burial in 1979, gold was thoroughly discredited by 1999. Two entire generations of investors had made more money investing in stocks and bonds from 1982-1999 than had ever been made before. (An investing generation is often thought as five years to10 years, since investing eras seem to change due to cyclical cycles about every five years.)

While the bull raged for stock and bond investors, investors allocated to gold received permanent disappointment. Gold was so out of favor and despised, that by the year 2000, the disgust with which most every professional investor viewed gold was palpable. There is a tried and true saying: Buy, only after all the willing, and unwilling sellers, have sold. This was the case with equities in 1979, with gold in 1999, and with gold stocks in 2001. You can see dramatic example of the relationship between gold and stocks in the chart further below.

Today, as the financial and developed world sit at the precipice of the Great Depression 2.0 while global deleveraging, deflation and recession cloud the headlines, gold investors are left wondering, is the gold bull market long in the tooth? I don't think so. Let's take a look at the supply and demand equation.

The fundamentals for gold are solid. Supply is decreasing as mining companies are still feeling the effects of 20 years of underinvestment that occurred from roughly 1985 until 2004.

In 2007, demand exceeded production by 1,074 metric tons. Total demand was 3,518 tons, while production was 2,444 tons. The imbalance between production supply and gold demand is filled by central bank sales.

The following table shows the top central bank gold holdings, measured in tons. The second number represents gold's share of each central banks' total foreign reserves. For a complete list of central bank gold holdings,

click here


It's interesting to note that gold represents just 2% of Japan and Russia and less than 1% of Chinese total foreign reserve assets. It will definitely bullish for gold if the central banks of China, Russia or Japan decide to materially increase accumulated bullion reserves.

Central banks hold just under 30,000 metric tons of gold -- approximately 19% of the total global supply. (The equivalent of 12 years of annual production, or eight years of annual gold demand at current consumption rates.) If you translate demand into dollars, the gold market is approximately a $95 billion market annually -- $850 gold per ounce and 3,500 tons of annual gold consumption.

At current consumption and production rates, central banks will run out of gold in 25 years. However, central banks won't divest of all their gold reserves, because they continue to harbor some notion that a currency needs to be backed by something more valuable than a printing press.

Gold production more than doubled over the past 40 years, pretty much growing in line with population growth. More than half of all gold ever mined has been produced since 1960, and more than 80% since 1900.


Gold Production vs. Population Growth

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Production has grown with population, however. Production peaked in 2001 and has since declined 5%, forcing ever more sales from central banks to meet demand growth. Major gold producers like





(NEM) - Get Newmont Corporation Report

, and in particular the South African miners


(HMY) - Get Harmony Gold Mining Co. Ltd. Report


Gold Fields

(GFI) - Get Gold Fields Ltd. Report

and others, have struggled to replace reserves, suffering from declining production at their major mines for much of this decade.

Annual World Gold Production

Click here for larger image.

I don't believe that production supply, despite significant new capital raises in the industry since 2004, is going to accelerate over the next decade. New production is just barely increasing faster than production declines at existing mining operations. Furthermore, it takes a minimum of seven years, and often as much as 12 years or more from the time of the discovery to the time gold is first mined. Also, it usually takes an additional five years to ramp production from initial production to full capacity. Consequently, any new discoveries in gold exploration today are more than a decade away from becoming producing mines.

Gold production has declined 5% since 2001

, according to the World Gold Council.

With the onset of the great commodities bear market in the early 1980s, capital for mining and exploration evaporated. By 1991, very little new money was being raised by gold companies-- neither for maintenance and development of existing mines, nor for exploration of previous discoveries.

While a small flurry of gold excitement in 1993 helped gold jump back to $400 and excited gold bugs that the bear market was over, the flurry was dashed in 1997 as the bull market in stocks reached its zenith -- according to market breadth -- and the gold rally was eviscerated by the discovery that the Indonesian discovery by Bre-X had been a complete Fraud.

Following nearly 20 years of underinvestment, annual gold production peaked in 2001 and has been declining for most of the past six years. Production growth in China and other countries, plus significant capital raises for mine expansion and new projects should propel production back to the 2001 level and beyond this year and next. Production declines in South Africa have been very significant, declining 8% in 2006 alone. South Africa used to account for fully two-thirds of all gold production; now it has declined to just 11% of global supply.

2006 Mine Production

While gold supply is stretched, demand is increasing, especially in China and India. As the Chinese and Indian economies have grown more than tenfold in the last 20 years, citizens have accumulated ever more wealth. For the average upwardly mobile Asian family, there are few safe options for capital preservation. Citizens have often chosen to keep their accumulated wealth in gold, often in gold jewelry.

Due to price elasticity, demand growth is volatile. As we can see in the second quarter of this year, the higher gold prices and slowing economy do seem to have reduced jewelry consumption year over year from more than 600 metric tons per quarter to 450 tons to 500 tons.

This decline has been met, however, with increased investor demand until the second quarter, when ETF demand disappeared while gold was correcting. In fact, investor demand is the big unknown. It is clearly tied to the price action. The more the price increases, the greater the investor demand. At 19% currently, investor demand has risen with the increasing gold price.

In the following chart, you can see the 200 year relationship between stocks --the Dow averages -- and gold. Note that despite the onerous corrections in gold, it has firmly remained in bullish mode, while the stock and bond markets have collapsed.

For more information about gold and the way it has acted from a historical context look at



We've certainly seen a few scary things that government can do lately --


(AIG) - Get American International Group, Inc. Report


Fannie Mae



Lehman Brothers



Bear Stearns

-- the capital destruction has been breathtaking. But no matter what governments have done: tax and spend, invade, be invaded, default, hyperinflate, gold has retained its purchasing power over five millennia. In the world today, there are only a couple of currencies that are older than 200 years.

And you can count on one hand the number of countries that have never defaulted on their debts. That's uncertainty. Yet, gold investors take comfort in knowing that gold is likely to have approximately the same value in 50 years as it does today. These days, that is comforting indeed.