The Analyst: Gold glitters in an uncertain world

Since even before the time of the ancient Egyptian empire, gold has been one of mankind's major stores of wealth. It has taken on almost mythical status; even today, few of us own more than a tiny amount of the precious metal. And, for many of those investing in gold throughout the 1980s and 1990s, profits were just as hard to come by.

Gold lost much of its shine after the price peaked in 1980 at $850 per ounce. It went into decline because central banks started to get a grip on inflation – and, because gold doesn't yield anything, other investment classes gained popularity. The decline in price brought with it a decline in production and exploration.

Here we can see the beginnings of gold's eventual recovery. As I have mentioned with other commodities, if production is scaled back but demand suddenly increases (even slightly) you can expect a price rise. That is exactly what has happened over the last six years.

It is therefore a shame that Gordon Brown didn't appreciate this in the late 1990s when he decided to sell half the national gold reserves at around $250 per ounce. The current price is $765 per ounce.

Of course, the vast majority of politicians (from all parties) haven't a clue when it comes to economics. Mr Brown would have done well to consult Graham Birch, who runs the Black Rock Merrill Lynch Gold and General fund, which is not only the best-known gold fund in the country, but also one that has kept going through all the bad times too.

The fund does not invest much in gold bullion, but instead buys the shares of gold mining companies. Generally speaking, the profits of the mining companies are geared to the gold price, meaning that any movement in the gold price will be magnified in their profits.

I think it is interesting to note that when this fund was launched in 1988, gold bullion was at around $450 per ounce. So the price of gold is up about 67 per cent since 1988 – but how has the fund performed over the same period? It is up by more than 2,000 per cent.

At present, more than half the fund is invested in gold-miners, with just 2 per cent of it in gold bullion. Remember that although the fund may benefit from a rise in the price of gold, it will also be tied to fluctuations in world stock markets.

The fund also invests in stocks relating to other precious commodities, including platinum, silver and diamonds, which are also likely to benefit from a supply and demand imbalance and from rising consumer wealth in emerging markets. It is this imbalance that is creating what Graham Birch calls a "perfect storm".

Of course, a number of other factors have come together at the same time, and these include a weakening US dollar – that always favours gold.

However, I think that, as always, supply and demand are the key issues. On the supply side, gold production peaked in 2001. Some 80 million ounces are mined each year, while only 20 million ounces are discovered through exploration. Therefore reserves are being depleted and production levels continue to fall.

This state of affairs is likely to continue because it takes a long time (10 years or more) to bring a mine into production, even assuming that you can find the gold in the first place.

Demand for the metal has been increasing, particularly from countries such as India that use jewellery in marriage dowries. There is also a strong possibility that many of the emerging markets with huge foreign reserves – especially China – are likely to diversify away from the dollar and US Treasury Bonds. It's hard to believe that gold will not be one of their chosen diversifiers.

Ian Cochran, the chief executive of Goldfields, the world's fourth-largest producer, has recently said: "I'm quite comfortable talking about $1,200 dollars per ounce for gold in the next 24 months." I have no idea whether this will happen, but it is interesting to consider that if the gold price had kept pace with Merrill Lynch Gold & General Fund over the years, it would now be trading at more than $8,000 per ounce. Now that's a thought.

In conclusion, given the huge world imbalances today, it really seems to make sense from a tactical viewpoint to have some money in gold. For the first time, I have bought gold in my self-invested personal pension. While I realise that there are other gold funds around, the Merrill Lynch fund has always been my first port of call.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent