Analysis from AdvisorAnalyst.com

Gold: Investment or Speculation?

For decades, gold has been considered an asset one either speculated upon or invested in as textbook, defensive asset allocation. However, as a result of either complacency toward diversification or the view that it is speculative, the market is under-invested in gold. Despite the huge success of the largest of the gold bullion ETFs SPDR Gold Shares, (GLD), for example remains tiny in the grand scheme of stock investing. It is only worth 0.4% of the S&P 500's market cap, and a smaller fraction still of the entire stock markets' capitalization, as of the end of October.

Since the credit crisis, gold has taken a bright new shine, as concerns over the economy, the future of the dollar, and inflation mount. The price of gold has recently risen to its all time nominal high of $1,218 (U.S.) per troy ounce, thanks in part to large central bank purchases by the likes of India, China, and Russia, as well as the drooping greenback.

But there is another factor adding to the precious metal's lustre and credibility as an investment this time around. That is the high level of sponsorship and conviction it has garnered from the likes of super-hedge fund managers, Paulson & Co.'s John Paulson, GreenLight Capital's David Einhorn, and Tudor Investment's Paul Tudor Jones, have all made massive commitments to gold bullion, as well as gold stocks, this year. Are these mere speculations, or are they long term investments?

Berkshire Hathaway's Warren Buffett, says there will always be other things that he would rather own. Gold, he says, "gets dug out of the ground in Africa or some place. Then we melt it down, dig another hole, transport it halfway round the world, then bury it again and pay people to stand around guarding it". It has, he argues, "no utility". There will always be other things that he would rather own.

John Paulson, head of Paulson & Co., on the other hand, whose long-term bets against subprime mortgages netted $20-billion in 2007 and 2008, now holds a gold bullion cache of 140 tonnes (est. October 31, 2009 - $4.3-billion), a notional amount larger than several countries combined. Paulson is also setting up an all gold bullion fund, in which he will be the largest investor. Paulson believes there will be a rush into gold. He says there are currently $200-trillion of investable assets globally, of which only $800-billion is gold.

David Einhorn, of Greenlight Capital, has also taken a sizable position in gold, with in his case, an irreverence to inflation or deflation. "If the chairman of the Fed is determined to debase the currency, he will succeed," said Einhorn. "Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself." Einhorn wrote in January, "I never thought we would ever buy gold or gold stocks." His father had been obsessed with the precious metal and lost money in it over a 30 year period.

David Rosenberg, Chief Strategist, Gluskin Sheff, a gold bull, takes an academic view, recently stating that the supply-demand fundamentals for gold are robust. Rosenberg recently shared his thoughts in an early December issue of his daily newsletter.

"If China were to lift their gold reserves to 5,000 tonnes, which is equivalent to about two years of global production, that shift in demand would boost the gold price by $800/oz to around $2,000 ($1,978) based on our models. If China moves towards 10,000 tonnes, well, that would end up taking the gold price to $2,623/ounce if our calculations are in the ball-park."

Whether gold is an investment or speculation revolves around the definition of investing. Investors like John Paulson, however, are highly controversial. It could be argued that either he's a gambler of gargantuan proportion, or an astute, extremely well informed, high-conviction investor. I'll bet on the latter.

In conclusion, Einhorn's learned indifference to the inflation-deflation debate and Rosenberg's academic view of the demand-supply curve for gold, in the context of China's future purchases, qualify, in my mind, as common sense, rather than the widely used currency disaster arguments.