Finding Gold in the Mainstream

The chart above shows how little gold has been sold by the 18 European countries covered under the Central Bank Gold Agreement. The annual limit is 400 metric tons, but through the first eight months of its latest fiscal year (ends September 2010), only a tenth of that amount changed hands, nearly all of it being sold by the International Monetary Fund.

Russia’s central bank added more than 26 metric tons to its reserves in the first quarter of 2010, according to the World Gold Council. The Philippines has boosted its gold reserves by about 10 metric tons, and China is widely believed to be quietly adding large quantities of gold to its vaults. China is the world’s largest producer and is consuming all of its production, so this supply is not seen in the market.

Gold mine supply also comes into play. After a nice bump up in 2009, gold mine output is on track to decline this year and in 2011 (chart) at the same time that investment demand is strong. The World Gold Council forecasts that overall gold consumption in China could double in the coming decade as income levels rise – it is very unlikely that China’s production will be able to keep the same pace.

Other appeal: gold’s historic non-correlation with other financial assets, household debt reduction and the uncertainties created by the efforts in Washington to raise tax rates and impose new regulatory schemes. And as we approach the important 2010 midterm elections, it would be no surprise to see government deficit spending climb even higher into the stratosphere to curry favor with the voting public.

Some extreme gold bulls are urging investors to move half or even more of their portfolio into gold – we are not in that camp. We consistently suggest that investors consider a maximum 10 percent allocation to gold-related assets – half in bullion or bullion ETFs and the other half in gold stocks or a good gold fund – and that they rebalance each year to capture the swings.

On the gold equities, our research via a basic regression analysis shows that gold equities appear undervalued by 8 percent to 9 percent relative to bullion. This may present a buying opportunity for long-time gold investors and those New York Times readers who are among the many new believers.