Issue #08

Gold is timeless money. For five millennia it has stood for money and maintained its purchasing power over time. We believe we are in about the 4th inning of a bullish Gold cycle. If you’ve read Tangible vs. Financial Assets on our website then you know our view that tangible and financial assets oscillate in 20 year cycles of out performance and underperformance. We are entering year 7 of that bullish cycle for Gold investments.

At Barnes Capital we overweight investments in the asset classes that are experiencing secular bull markets. Today that sector is tangible assets (as opposed to financial assets). Tangible assets are real estate, commodities, precious metals, gems and collectibles. Financial assets are IOU’s, either debt (bonds) or ownership interests (equity). We believe that bonds and equities will deliver below below average returns over the next 5-10 years. Concurrently, we believe that Gold and other tangible assets are attractive assets for the foreseeable future.

Why buy Gold?

1. Diversification: The theory of diversification is that you always want some of your assets moving in the opposite direction of your other assets. Gold is inversely correlated to the dollar, and it is not correlated to stocks, or bonds. As such, it’s pretty likely to do well, if stocks and bonds have modest or negative returns.
2. Supply: The bear market in Gold lasted from 1984 until 2002. Funds for exploration of existing and new mines evaporated and very little exploration occurred. At the same time very little reinvestment in existing plant, equipment, and exploration was made. As a consequence of 20 years of under-investment, annual gold production is presently in decline. Current mines have not been able to replace their reserves. While the price of Gold rose 50% from $400 to $600 per ounce, Gold production declined 3% in 2005. It takes 7 to 10 years to bring a new gold mine into production, so any new discoveries today are many years away from fulfilling new demand.
3. Demand: In the same period of time, a billion new souls entered the planet, and China and India (Chindia), two of the main consumers and acquirers of gold and silver, increased the size of their economies by about 7x in these last 20 years. Gold is sold to the middle and upper classes of Chindia by the gram. It is marketed with different ways, but may go for anywhere from $19 to $22 per gram at current prices. There are many different reasons why India and China citizens are comfortable keeping some of their assets in Gold, from the tradition of Gold jewelry in Indian weddings, to the lessons of the millennia in China’s merchant class that has seen political systems and currencies come and go.
4. Inflation Hedge: The nature of things is that prices rise. They do so, because the alternative, deflation, is worse. Gold, above all else, is an accepted standard of value that cannot be depreciated. If you look at what an ounce of Gold bought 100 years ago, it bought a nice set of clothes. Today, $650, (the current price of an ounce of Gold) still buys a fine set of clothes. That may not sound earth-shattering, but it is. A dollar in 1945 bought a nice steak dinner with drinks and everything at a very good NYC restaurant. What does that meal cost today, $100, $200? Theoretically one can say that your investments would have compounded at a rate in order to grow from $1 to $100. And they may have, but then again, they may not have.
5. Standard of Value: No matter what governments do: inflate currencies, conduct war, hyper inflate, gold has retained its purchasing power over five millennia. In the world today there are only a couple of currencies that are older than 200 years old. Investors know that Gold will have an approximate value in 20 years of what it has today. That is comforting.

For additional information about understanding what is driving Gold prices, click here to look at US Global Investors excellent page at: www.usfunds.com

In the next issue of Insight, we will present our views on Asset Allocation policy for 2007. Our next letter will come out around December 15th. Stay well.

Daniel Barnes, CFA

Barnes Capital is a Registered Investment Advisor located at in downtown Lafayette. With RB Capital Management, Barnes Capital develops custom tailored portfolios for its clients. Specialized in retirement income portfolios, financial planning in an integral part of our process. Call 925-284-3503.

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