Black Gold or Real Gold?

03/03/2008 12:00 am EST

Focus: STOCKS

Richard Band

Editor, Profitable Investing

Richard Band, editor of Profitable Investing, argues that buying oil stocks can give you much of what you get from buying gold—plus an extra kick.

Investors are hearing a lot of buzz about gold these days. Small wonder, too: the yellow metal has nearly quadrupled, in dollar terms, since 2001. Just since last summer, bullion has soared more than 40%.

These increases are dazzling. [But] before making a commitment to gold today, we need to ask ourselves whether the economic fundamentals, as they now stand, will continue to support higher prices for the metal in coming months and years.

On the plus side, I can cite several major factors:

• World gold production peaked in 2001, after rising rapidly in the 1980s and 1990s, [while] central bank holdings of the Midas metal have shrunk 11% in the past decade. Thus, two important sources of supply are diminishing.

• Newly wealthy individuals, particularly in Asia, are accumulating gold. Jewelry demand in China, India, and the Middle East climbed smartly in 2007, despite lofty bullion prices.

• Geopolitical tensions and the weak US dollar are driving foreign investors (including some central banks) to hoard gold.

• Exchange traded funds, such as the StreetTracks Gold SharesETF (NYSE: GLD), have made it vastly cheaper and easier for investors of all sizes to own gold.

The more difficult question, though, is whether today’s gold price already fully reflects these favorable developments—and may, perhaps, be overlooking some negatives. For instance, a global economic slowdown could crimp jewelry demand. Publicly traded jewelry retailers on both side of the Atlantic logged disappointing Christmas sales, a possible harbinger of weakening gold demand.

Investors may also lose some of their enthusiasm for gold if, as I expect, a slowing US economy tamps down the reported inflation numbers for the rest of this year. Benign inflation figures could spark a rally in the dollar, lessening the attraction of “anti-dollar” hedges like gold in the eyes of foreign investors.

To justify buying gold at today’s prices, you should try to assess the odds that another raging inflation might take hold, as it did 30 years ago. Myself, I think the chances are pretty slim.

Instead of loading up on gold, which yields no cash income, I prefer to salt away dividend-paying oil stocks like BP (NYSE: BP) and Chevron (NYSE: CVX). Oil, like gold, is an inflation hedge; but it’s also an essential commodity, rather than a luxury item.

BP, by the way, is yielding almost 5% after a fat February dividend increase. In the past 20 years, the dollar price of gold has risen only about 3% a year. Thus, if past is prologue, BP’s dividend alone will—over long stretches—produce more wealth than you’ll gain from an increase in the gold price.

So, buy BP at $69 or less and CVX at $86 or less. (BP closed below $65 Friday while CVX closed below $87—Editor.)

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