Between 2001 and 2006, the average annual return on gold was 10.7%, compared with 7.1% on domestic equities, 1.7% on global bonds and 15.4% on real estate (see Compound Annual Growth Rates table), a track record that makes it hard to ignore the role the precious metal can play in mainstream portfolios. Investors with an understanding of gold’s price drivers benefited from taking positions relatively early in the period, recognising the likely impact of excess liquidity, turbulent equity markets, an overvalued dollar and geopolitical strife on this most precious of safe havens. And their wisdom has been rewarded.

Compound Annual Growth Rates (%) to End 2006 Data: Global Insight, Lehman Brothers

However, it is also true that gold’s performance through much of the 1980s and 1990s was lacklustre.  This bear market stood in stark contrast both to the striking returns on gold that had been seen in the 1970s, and to the performance of equities, particularly in the bull market enjoyed in the last decade of the 20th century.  Indeed, analysis of the gold price since the early 1970s provides rich pickings for those seeking to deepen their understanding of the factors that move this market today.

The contrast also raises the question of how long gold’s recent strong performance can be expected to persist, and how to think about the strategic – rather than tactical – risk premium on gold.  Over the very long run, gold has proven to be an effective inflation hedge an investment characteristic that is appealing to investors concerned with defending the real purchasing power of their assets.  This property has often been expressed in terms of a 'constant real gold price' a characteristic that may seem to be at odds with the very positive returns seen over the last few years.  Short-Run and Long-Run Determinants of the Price of Gold provides a framework for reconciling this apparent contradiction.

For the moment, to the extent that tactical factors – such as the outlook for gold demand relative to supply, the dollar, interest rates and inflationary expectations – continue to be supportive of gold, there are good grounds for optimism.  Independent gold price forecasts can be found at: LBMA and in Reuters and Bloomberg polls.