Golden Opportunity

The 21st century has been kind to gold. The precious metal has more than tripled in value since it welcomed the new millennium at around $250 an ounce. There’s excitement in the air that it might soon surpass its all-time record high of $850 set in 1980. The surge has ignited a rally in mining stocks as well.

The run-up stems from a confluence of both supply and demand trends. The rocky stock market, the subprime mess, falling interest rates, soaring oil prices, heightened fears of inflation, and an ever-weakening dollar combined to send investors straight to gold — an alternative investment that moves inversely with the dollar, and one that is seen as both the ultimate safe harbor and a classic inflation hedge. Then there’s the heavy demand for jewelry among the growing middle classes of emerging economies in India, China, and the Middle East. Fabrication, mostly jewelry, accounts for 80 percent of the gold consumed worldwide. Meanwhile, production has been mostly stagnant for the past decade. Global output has increased at an annual rate of less than 1 percent, barely half the rate at which demand has grown.

The question for investors as we move into 2008: Is there much left of this gold rush?

A pullback could come at any time, given the explosive rally in gold prices in recent months. Longer term, it comes down to a call on several economic trends. Gold prices will fall if we enter a global recession that depresses personal incomes and industrial uses of gold, or if the dollar rebounds and inflation remains low. Such trends, singly or together, could put a brake on gold prices.

But if the global boom continues, inflation ticks up, and the dollar ticks down, the long-term rally could continue indefinitely. And another stock market crisis could turn more investors into gold bugs.

Unless economic trends apply the brakes, a test of the $850-an-ounce historic high seems inevitable. Even predictions of $1,000 or more aren’t terribly outlandish. But before you get too excited about hopping on the bandwagon, remember that in inflation-adjusted terms, gold’s 1980 peak translates to $1,700 today. Think about it: even after gold’s glimmering record since 2000, it’s still not back up to half its inflation-adjusted level of 28 years ago. While a price chart shows gold moving in an exhilarating trajectory since 2000, the 30-year chart shows two peaks on either side of a long, low valley.

If you’re still interested in putting gold in your portfolio, a couple of final caveats: Even true believers suggest limiting gold to no more than 5 percent to 10 percent of your total investments. And you shouldn’t own the metal directly. That’s a costly hassle. The best proxy is an exchange-traded fund. Stocks of gold mining companies provide greater opportunity but come with greater risks — operating risk, geologic risk, financial market risk, and in some cases, geopolitical risk.

Kevin McCormally is the editorial director of Kiplinger’s Personal Finance magazine. Visit kiplinger.com.