Opening Shot
Gold Is Ready for a Fall
My advice is to wait for a correction in the price of gold and then buy mining stocks.
By James K. Glassman, Contributing Editor, Kiplinger's Personal Finance
August 2010
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Peter Bernstein began his book The Power of Gold: The History of an Obsession, published in 2000, with a parable about a man who goes to sea carrying his wealth in a bag of gold coins. A storm comes up, and the captain tells the passengers to abandon ship. The man straps the bag to his waist, jumps into the sea, quickly sinks to the bottom and drowns.
TRY OUR QUIZ: ARE YOU GOLD'S FOOL?
For an entire generation, investors who held on to gold had much in common with the unfortunate passenger. Yes, gold soared from about $100 an ounce in 1976 to more than $800 in 1980, but it soon collapsed and traded consistently below $400 for most of the next quarter-century or so. Meanwhile, from 1980 on, the Dow Jones industrials rose more than tenfold.
The fear premium.
Gold's previous bull market coincided with a sharp increase in inflation. Today, with inflation tame, fear seems to be the source of the obsession that has led to a tripling of bullion prices in barely five years. At a time when many investors see government deficits spiraling out of control, gold appears an obvious place to store cash until the storm blows over. As a result, the metal enjoys a fear premium. Without it, gold, which sold for $1,220 an ounce in early June, would trade at $800, says Michael Crook, of Barclays.
It is easier than ever to buy gold. SPDR Gold Shares (symbol GLD), an exchange-traded fund that tracks the price of bullion, now holds $50 billion. Investors who are especially fearful can own physical gold, in the form of bars or coins (American Eagles, for example). You can keep the yellow metal in a safe-deposit box—unless you're worried that someday the bank doors won't open—or even bury it in your backyard.
In case you haven't guessed, I am skeptical of gold as a fear-based investment. You should certainly be worried about future inflation. But there are far better hedges than gold, which historically has exhibited little correlation to the consumer price index. By contrast, returns of Treasury inflation-protected securities are tied directly to the general level of consumer prices.
Worried about European countries defaulting on their debts? U.S. Treasury bonds should hold their value as investors stampede to safe havens. (See Treasuries: The Brand to Trust.) Concerned about the U.S. defaulting on its debt? My advice is to pull the covers over your head and go back to sleep. Do you dread terror attacks or other unforeseen horrors? The best hedge isn't gold but an ETF, such as ProShares Short S&P 500 (SH), that rises when the stock market goes down.
Still, there are reasons to buy gold. Demand might rise because the new rich, especially in developing nations, may buy more jewelry or because the Chinese government, which now holds only 1.6% of its reserves in gold, may decide to diversify out of dollars and euros. (For more on China’s currency moves, see Interpreting the Yuan.)
Supply is a more complicated matter. Imagine what would happen if the price of gold dropped sharply as the fear premium dissipated. Mining companies would probably cut back on production, which in turn would cause prices to rise.
My advice is to wait for a correction in the price of gold and then buy mining stocks. The stocks often pay dividends (typically small) and benefit from both rising productivity and leverage (meaning that the shares tend to rise more dramatically than the price of gold). Among top producers are Barrick Gold (ABX), with 140 million ounces of reserves, and Newmont Mining (NEM), with 92 million ounces.
Gold is not just an obsession, it is a mystery. Predicting the direction of its price is fraught with peril. "Bullion has no direct link to economic growth, as do other commodities, doesn't earn a return, offers limited hedging advantages and hasn't kept pace with inflation." All true. But since Michael Sesit wrote those words on Bloomberg.com on October 5, 2007, just days before the stock market peaked, the price of gold has climbed 65%. Proceed with caution.
James K. Glassman is executive director of the George W. Bush Institute in Dallas. His next investing book will be published in early 2011.
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Reader Comments (5)
Posted by: Nomen at 07/15/2010 07:08:59 PM
"Gold Is Ready for a Fall"???????? What investment isn't?????? The truly fearful are buying lead.
Posted by: David at 07/16/2010 01:18:50 AM
I suggest Mr. Glass read "Fail-Safe" investing by Harry Browne and then take a good look at the historical performance of a portfolio which is: 25 % S&P 500, 25 % Gold, 25% Long term US Bonds and 25 % cash. Then he can tell me whether or not he believes Gold is still not a good long term investment. Better than a plan built by a man who wrote a book entitled Dow 36,000.
Posted by: Bill Porter at 07/17/2010 10:51:34 AM
Its amazing how supposed people in the know are so quick to recommend stocks, even gold stocks, and put down the physical ownership of gold itself. I can show you millions of people that wish they had owned physical gold instead of stocks over the last 5 years. If the regulators would stop the manipulation of the gold and silver, you would see the true price of gold should be $4000 and silver $300. Then what would these stock pushers have to say? If Goldman Sachs sold stock puts by the thousands that they didn't even have, you would see the price of stocks go down tremendously. That is the way they do silver, sell puts into the futures market more than all the silver in existence, and drive the prices down artificially. With stocks, the manipulators just put out all kinds of negative propaganda on stocks after they have sold short, then reverse the process and sell long. Stocks are worse than Vegas. Gold and Silver are physical elements, and they will be until the end of time.
Posted by: Bryan at 08/04/2010 02:17:30 PM
Gold will not fall forever, if investors actually stored the metal themselves and used the contango rule and wait for huge smart money to push down the paper price eventually gold would experience a squeeze not seen in our lifetime. If it wernt for China I would agree that the derivatives game would last far longer. But its damanging the future values of paper money and the ...smart economists that are blind to it are the ones that dont see history before 1971.Yes the paper price of gold will go up and down. But...govts like china push their citizens to invest in gold (actually they are loading up on it also but with 1.3 billion people they can say its their citizens.) The etfs are not gonna get you the premium bullion will, especially small denomination sub 1 ounce coins.I shouldnt have to explain why gold didnt perform well from 1981-2001, there isnt 1 ounce of gold for each person on the earth living today and thats including all the gold ever extracted from the ground as far as recorded history goes.The market is growing and there wont be enough gold to support the true demand, If you buy gold to store it, dont cash it in, use paper to take profits, but the smart people never sell their actual bullion especially when the market is falling,Gold is universal and with the new wealth we exported to china and the middle east, we will slowly lose control of the...game that props up the dollar and devalues gold. I think the best way to use gold is to develop banks to allow personal delivered gold to hold as a backing for a private consumer credit line or card based upon 50-75% of spot ,Like what BIS does with banks. This would benefit the economy with putting trillions of gold backed credit over the revaluation phase alone with just 40% useage.T he new money or existing money used would be true growth since both parties would actually not need to hide losses, Eventually it would push the price of gold out of reach from a middle class family...Now that we are really in a world economy gold is going to become more important...a BIS for private gold is win win for investor and bank and it keeps more money in the economy so gold haters benifit also.
Posted by: Sean at 09/14/2010 10:10:24 AM
Mr Glassman lost all credibility as a financial expert when he said "But there are far better hedges than gold, which historically has exhibited little correlation to the consumer price index." Anyone who knows anything about the CPI knows that it is a largely bogus parameter that does not accurately capture or reflect true, effective inflation that the average consumer experiences. The CPI was created by politicians to conceal their inflationary policies. The CPI has been manipulated over the years to lowball true inflation, again for the purposes of politicans making themselves look good so they can get re-elected. Gold's no panacea, but in a world of endless global QE and orgiastic governmental spending in all forms, throwaway paper fiat money is not a viable alternative to precious metals (for all of their flaws). The old saying "the government can't print more gold" is a true statement, and you certainly can't argue with gold's historical record as a storehouse of wealth spanning over 5000 years. The Pharaos' sarcophagi were made of GOLD, not fiat papier mache - there's a reason for that!