Insights & Advice


All that Glitters

As the price of an ounce of gold bullion gyrates around the $1,000 mark, I continue to receive numerous calls concerning the precious metal from clients, readers and even people who would normally never consider investing in financial markets. What is it about gold that brings out the best and worst in us?

By accident, I became involved in gold as far back as 1982, when I first visited the vast, world-class, producing mines in South Africa and surrounding nations while working for one of Wall Street’s investment banks. Since then, I’ve probably been in just about every major metals and/or diamond mine in the world.

Gold mining is a fairly straight forward operation. Back in the day, (as in the grand mines of South Africa and Australia), great holes were excavated with some reaching down miles into the earth. There were armies of laborers, travelling up and down in huge gated elevators, mining veins of ore using everything from shovels and picks to today’s multi-million dollar earth-moving equipment. They wrestled the glittering metal back to the surface where it was processed with nasty, polluting chemicals and transformed in furnaces into bricks of gold measured in troy ounces.

Today, thanks to technological breakthroughs, there are easier and less costly methods available, mostly executed on the surface where gold is leached from piles of ore using chemicals that can and do pollute the environment. As a witness to the mining process, I long ago lost any emotional attachment to gold, silver or any other precious metals, including diamonds. To me, in a perfect world, gold would simply be a product, like any other, and function under the same economic constraints of supply and demand that govern other commodities and goods. Unfortunately, through the years I’ve learned it isn’t a perfect world and gold is not simply a commodity. Here’s why.

Gold occupies a central place in humanity’s history. Stories concerning gold are recorded in our earliest history books and religious texts. The Bible, the Koran and the Torah mention the precious metal in some way or another. Maybe that’s where we first developed an attachment to gold.

In practical terms, gold offered our ancestors a way of protecting wealth throughout the centuries, providing a safe haven in times of economic calamity brought on by war, pestilence, political and social change. It was and still is readily transferrable, at least in the quantity that most people own, in the form of coins, jewelry and even sheets of metal thinner than paper. In the Middle East, India and China, among other cultures, gold jewelry is taken seriously as both a decoration in good times and a source of money in bad times. For example, as gold approached $1,000/ounce last year, lines of Indian consumers queued up to sell their jewelry for cash. India is the largest importer and consumer of gold in the world, importing 700-800 tons of the yellow metal each year which is 25% of world consumption.

Gold for many is also an alternative currency; it does not rely on an issuer’s promise to pay, (like paper currencies) and thus offers a refuge from default risk. Readers may recall the devaluation of the German currency after their defeat in WWI or the recent hyperinflation in Zimbabwe as examples of currencies gone amuck.

There is also some evidence that gold is a long-term hedge against inflation. It keeps its purchasing power, its defenders argue, in terms of real goods and services, although not all the time. Sure, if you are going to go back several hundred years or so there may be some merit to that argument, but just in my lifetime I’ve seen gold sell for as little as $35/ounce and as high as $1,030. Over the last eight years, however, the price has been in an uptrend from $272 in 2000 to $833 in 2007, $904 in 2008 and now around $1,000 an ounce. Yet, there have been instances where its price underperformed other asset classes over an extended period of time.

Still, for many, gold can be an emotional subject. I have seen investment advisors who refuse to buy gold or gold stocks and who poke fun at those who do buy the metal. I believe that decision is just as irrational as those who forecast the end of the world in which gold will be the only reliable investment to own.

Aside from those extremists, I have met many investors who feel gold is more than a commodity. It is an asset, they say, that they can trust because it is real and holds its value over the long term. It provides for them insurance against extreme movements that often occur in the value of traditional asset classes. That may be true, but not all the time. Take, for example, the declines in the real estate and stock markets last year. Gold performed nicely, at least in the first half of the year along with most other commodities, but they all fell apart like every other asset class in the second half. Yet I still read advertisements today that tout gold and other commodities as necessary diversification tools in portfolios that have traditionally shunned commodities as an asset class.

I believe gold’s popularity among investors coincides with an increase in the fear factor and today’s media are certainly proficient in heightening that level on short notice. This year we have had more than our share of doomsayers predicting either deflation or inflation depending on the outlook. Either way, the gold bugs have you coming and going. If it is deflation, brought on by a crippling recession/depression, then gold is a safe haven. If on the other hand, you fear inflation, than the old hedge-against-inflation theory works best.

For today’s investor, there are numerous ways to “own” gold. Some buy gold coins because they offer a collector’s premium and are actually permitted to be owned in IRA accounts. You can also buy bullion, although that is both an expensive proposition and cumbersome to hold, store and sell. Futures are another avenue although the futures market is highly volatile, requires capital and has tax implications that may be too complex for the average investor. The advent of exchange traded funds (ETFs) now offers an easy way for investors to buy shares in a fund that invests in the precious metal or at least futures in gold. There are also gold mining stocks and mutual funds that invest in these equities, although buyer beware when investing in gold stocks and funds. Usually, when stock markets decline, gold stocks follow suit no matter what happens to the price of gold.

Although I am not a gold bug, I have held gold and gold stocks often throughout my career. The key, however, is that I have purchased gold when few were interested and sold it when everyone was chasing it. Have you ever noticed, for example, that a multitude of ads to buy gold start appearing as the metal runs up in price, like now? I have often wondered where all these gold experts were when the price was $200 or $300 an ounce lower. Wouldn’t that have been a better time to buy?

So where do I see gold going over the next six to nine months? I think it can go higher, maybe, as high as $1,200-$1,300/ounce. Many technical analysts agree with that forecast. Given its present price, that is not a bad return. But buyers should be aware that on a fundamental basis (the price gold should trade based on the supply and demand of gold consumption) gold is overvalued. You are instead betting on investor sentiment, on future inflation expectations and guesses on the U.S. dollars continued decline. If none of theses scenarios play out, you could be looking at a big hole in your portfolio instead of profits. So now that you know the risks, it’s your move.

Posted in A Few Dollars More, Portfolio Advice