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By Michael Wallace
Business Week Online
http://www.businessweek.com

Has gold regained its long-term luster?

It took a beating in the '90s, but a host of
uncertainties has sent prices soaring as anxious
investors seek refuge in the precious metal .

The price of gold has been on a tear recently,
surging $25, to $305 per ounce, as investors seek
a safe haven from a variety of worries, including
Argentina's debt default, Japan's shaky banking
system, and Enron-fueled stock market woes in the
U.S. Especially now, in the aftermath of the Enron
disaster, there's an elegant simplicity to investing
in gold. You don't need a congressional hearing
to decipher its balance sheet or income statement.
It's worth what the market says it's worth.

Gold is by nature a cyclical asset, though its appeal
as a hedge against inflation had dimmed in the '90's
era of waning inflationary pressure. During that period,
the market price of the precious metal has been in a
relentless downdraft, falling from a high of over $462
per ounce in 1990 to a low of $251.70 on August 18,
1999. But gold's long losing streak may finally be
at an end.

Along with the gradual recovery in the U.S.
economy, a combination of aggressive monetary
and fiscal forces may set the stage for higher
inflation ahead -- boosting gold's appeal. The
Federal Reserve's 11 rate cuts since January 2001,
have pumped massive liquidity into the U.S. financial
system. And President Bush's fiscal 2003 budget
signals an inevitable return to deficit spending,
though the shelved U.S. stimulus bill and the global
lack of pricing power should help temper gains
ahead.

A PREMIUM ON SAFETY. Add to this the
increasing nervousness about the health of world
economies and banking systems, and nervous
investors could once again pile into the perceived
safety of gold.

The list of concerns that could drive gold's price
even higher is daunting. Corporate defaults reached
record levels in 2001, and, despite signs of an
economic recovery, are on pace to break that mark
in 2002. Argentina defaulted on its sovereign debt
and its banking system has plunged into chaos.
Japan is in the grip of deflation, and its banking
system is coming under increasing pressure.
(Indeed, recent press reports indicate that worried
Japanese investors have been buying gold bars.)
The latest worry: the viral spread of accounting
irregularities among previously high-growth
energy and telecommunications companies.

These events can only enhance gold's safety
premium. Sure, gold investors have been burned
before -- the price has run up sporadically in recent
years, thanks to short squeezes, only to drift back
down again -- and recent gains may be just
another flash in the pan. But some fundamental
signs suggest that the metal's latest comeback
could prove more durable.

The past decade was brutal for gold bugs. In the
late '90s, even central banks, spurred by budget
surpluses and monetary union in Europe, opted
to pare down their stockpiles -- among the biggest
in the world -- and lend out reserves for a nominal
return of 1 to 2 percent. And gold producers
themselves seemed to put little apparent faith in
the market's value of their stock-in-trade. They
have been utilizing vast and complicated
forward-hedging schemes -- through the derivative
markets -- to lock in a price for their output. In fact,
as demand exceeded their production on
occasion, they found themselves caught short --
needing to purchase some of the gold required to
satisfy their hedges. Now those produces may be
in line for a reversal of fortune.

ECONOMIC MIRROR. Buy-and-hold gold
investors are ready. They've always been a
hardy breed, willing to forego interest or dividends
-- and incur storage costs -- for the perceived
benefit of security and the possibility of price
appreciation. Gold-mining stocks, which hit
record highs recently, are probably a more
efficient way of investing in the metal (as opposed
to, say, storing several thousand ounces in your
basement). But they can be subject to
company-specific country or political risk -- with
mining giant Freeport McMoRan's recent
misadventures in Indonesia being the most
recent example.

To be sure, gold is at best only a loose proxy
for the economic cycle and market instability.
And the precious metal, the classic insider's
asset, is costly to hold and subject to impulsive,
volatile price moves -- and supply-demand
dynamics that are often mystifying, even to
market veterans. So while a new golden age
may indeed be dawning for the metal, investors
lured by its recent ascendancy would do well to
remember those caveats.

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Wallace is chief market strategist for S&P/MMS
International.