A Golden Opportunity

Robert Hsu, March 02, 2006

For much of my career as a professional investor, I regarded gold as a barbaric relic of antiquity. But in the summer of 2004, when oil broke through $40 a barrel, I realized that we'd entered a new era -- a multi-year commodity bull market driven by emerging economies and led by China. My perception of gold changed.

I bought gold mining stocks then because I knew how much the Chinese love gold. Gold rings, necklaces and metals are favorite gifts between family members in China, especially among the older generation. Additional demand from India and the Middle East also contributed to this new bull market in gold. As oil money flooded the coffers of OPEC nation Treasuries, the growing distrust between Islamic nations and the West prompted oil sheikhs to diversify their dollar holdings into gold.

Another important upside catalyst just occurred in January, when China's State Administration of Foreign Exchange announced that it wanted to take a more active stance in managing its $800 billion foreign reserves. Simply put, this means China will buy less dollar and more gold. That's significant because the Chinese central bank is currently the second-largest holder of U.S. Treasuries after Bank of Japan.

According to the IMF, China currently has just 1.4% of its total foreign exchange reserve in gold–the lowest amongst major central banks. Many central banks have more than 5% of their total reserves in gold bullions. If China boosts its gold holdings (currently at 600 tons) to 5% of its total reserves, it will need to buy an additional 1,550 tons of gold -- that's over 60% of the world's total mining supply in 2005!

Even if China only shifts a small portion of its reserves to gold, the effect on gold prices will be staggering. And rumors are circulating in China that the shift to gold has already begun.

Between the Chinese central bank, Islamic oil money, and jewelry demand from emerging economies like India, gold is well set for another leg up in its bull market. I believe that over the next two years, gold prices will challenge the all-time high of $831 an ounce, reached in January of 1980. That would be a 45% pop from current prices.

We want in on this action, but I don't think mining stocks are the way to go anymore with gold. The purest way to participate in a gold bullion rally (without the logistical hassles of buying the yellow metal directly) is through the streetTRACKS Gold Trust ETF (NYSE: GLD). GLD is an exchange-traded investment trust backed by gold bullion, and its price tracks the performance of the metal. The shares can be bought and sold instantly through any standard brokerage account and have an average daily trading volume of over three million shares. The ease of use, liquidity and lack of sales charges makes the Gold ETF a unique and surefire way to ride the next wave of the bull market in gold.

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