Gold has traditionally been the investment of choice for persons seeking a safe haven from uncertainty and weakening US dollar. Empirical evidence indicates a high negative correlation between gold prices and the US dollar. The graph below illustrates a time series contrasting the dollar/euro exchange rate and the price of gold over a 16-month period.

Last year the war with Iraq, the threat of terrorism, and the fall of the US dollar prompted a gold rush. Gold started the first week of trading in 2004 by hitting a near 14-year high as the dollar fell to a fresh record low against the euro ($1.2695). Bullion peaked at $418.25 beating the eight-year high of $417.4 to reach a level unseen since February 1990.

So what is the forecast for 2004? The price of gold over the coming months is expected to rise on the back of a continuing dollar weakening and international uncertainty. The extent of the dollar weakening and thus the price of gold will depend greatly on economic conditions in the US. These include the level of twin deficits (budget deficits and current account) which have reached 10% of GDP, the level of consumer spending which has driven high import demand, risks of terrorism and interest rates adjustments. There is also the concern that Asian central banks could be tempted to alter their foreign exchange reserve allocations if the dollar continues to lose value. This will immediately place pressure on the dollar.

Is gold a good investment?

The answer is yes in today's market environment but, first, a word of caution. Gold prices are heavily dependent on supply and demand for gold. In this context two opposing forces could ultimately dictate future spot prices.

Firstly, gold miners hedged their production by selling gold in advance and caused supply shortages. This caused upward pressure on gold prices. With rising prices producers have stopped hedging. If supply once again becomes plentiful prices will fall.

Secondly, this increase in supply could be met by a corresponding increase in demand for gold by firms that use gold as a factor of production. Asian countries such as Japan and China whose economies are growing rapidly look likely to absorb this supply. This would in turn keep prices buoyant.

Finally, for reasons of diversification private investors interested in gold should use funds rather than specific gold related equities. Any investor who wants to invest in gold bullion, coins or small bars must be aware that storage costs and commission may apply.

So why invest in gold now? For those holding investments denominated in US dollars, gold represents an excellent way to hedge against potential currency loss. One of the highlights of 2003 was the dollar weakening and as stated earlier there are no signs of turnaround at least for the next six to nine months, unless there is an intervention from the Federal Reserve or the the European Central Bank.

Any investor who held gold throughout 2003 will be satisfied to know that his investment increased by 20%. Though it is not recommended to use gold as a core holding in a portfolio, it does represent a more cautious way of achieving capital gains. Gold thus represents a good complement to one's portfolio.

Through the best of times and the worst of times, gold endures. In a research paper by Harmston, Jastram's work on the long-term purchasing power of gold was updated. The study concluded among other issues that over the long term, despite price fluctuations, gold has consistently reverted to its historic purchasing power parity.

Gold has also proved to be an effective preserver of wealth. More importantly however, gold has been less volatile in terms of price than other assets, softening any negative shocks and offering investors the time to alter their investment strategy without suffering large losses.

Mark Azzopardi, MA Finance, B.Com., is investment and finance director of Jesmond Mizzi Financial Services Ltd. E-mail: mazzopardi@jmfs.net.

The value of investments can go down as well as up. Past performance is no guarantee for future performance. This article does not intend to give investment advice and the contents therein should not be construed as such. Readers are encouraged to seek professional advice regarding their personal financial situation.