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The Magi’s Gift

December 23rd, 2007 at 09:28 am

In the biblical story of the birth of Christ, the Magi gave Jesus gold, frankincense and myrrh. As many of us celebrate the Christmas season, perhaps we should consider giving ourselves one of these gifts, the gift of gold.

While I have never been a gold enthusiast, gold can be an excellent hedge against insipient inflation. In the 1970’s gold was a good investment during the extended “stagflation” that the US experienced.

The nominal price of gold has increased by approximately 75% over the past five years and is now trading at approximately $800 per ounce. However, the Euro has also increased in value against the dollar by approximately 40% over the same 5 year period. Thus, more than ½ of the increase in the price of gold can be attributed to the declining value of the dollar.

With the recent recognition that the CPI is dramatically increasing, it is possible that the US economy may soon face an extended period in which the economy is flat to negative and inflation is above the historical 3% average. If this occurs, it is likely that gold will once again become more valuable as a hedge against increased inflationary pressure.

You may be thinking that gold is already near its all time high of $850/oz. (reached in 1980), so where is the upside of buying gold at $800/oz. ? While in nominal terms that thinking is correct, in inflation adjusted dollars, the $850/oz in 1980 is actually $2145/oz. in 2007 dollars. Thus, on an inflation adjusted basis, gold is now trading at $317/oz. in 1980 dollars.

I am not suggesting that anyone sell all of their stocks and bonds and use the proceeds to buy gold. However, proper asset allocation requires us to look at present economic conditions. If inflation does increase in 2008 and if the dollar remains weak, the odds are high that the price of gold in US dollars could increase. Thus, it may be prudent to put a small amount (5% or less) of your liquid assets into gold, until economic conditions change.

If you decide to add gold to your portfolio, one of the easiest ways of owning gold is through Exchange Traded Funds (ETFs). One such ETF is the streetTRACKS Gold Shares ETF, with the call symbol GLD. This ETF is traded like a stock and is easy and inexpensive to buy and sell through a discount brokerage house.

Gold investments are not for everyone. However, if you think that inflation will rise in 2008 and the dollar will remain weak, adding to your portfolio the “Magi’s gift” may increase your portfolio returns in 2008.

I hope that you have a joy filled Christmas and a Happy and Prosperous New Year.

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