Gold: Why and How to own it
In my last post, 'Don't be a Rabbit in the Headlights' I stated the following:
'Turning
to investments it becomes slightly easier. Basically the majority of
things will do badly, including stock markets and property. Stock
markets typically halve during these periods, and property, as I have
already alluded to, is seriously overvalued.
The one ray of light
is the precious metals. They will continue to act as a hedge against the
global crisis, and the more the crisis unfolds the better they will
do.'
In this post I intend to firstly show you that the precious
metals sector still has a long way to go before it peaks, and then look
at the various ways you can gain exposure to it, depending on your
individual appetite for risk.
Before we get started I want to point
out that for simplicitys sake I will be talking mainly about gold.
However, silver will also benefit and will loosely follow gold's moves
although not exactly (gold tends to lead the PM's sector moves, whilst
silver often lags initially and then catches up explosively).
Gold has had a tremendous move since the $255 low in 2001, reaching an
all time high of $1918 in August of last year. At first glance this
seems extreme and would suggest that the top has been set, however to
help get a better understanding we need to look at both what preceded
this move, and how normal bull market cycles climax. Once we get this
perspective we will be able to see whether what we have witnessed thus
far tallies with what we should be seeing.
So, to help put the move from 2001 into perspective, what happened in the years prior?
The last cyclical gold bull market ran from January 1970 to January
1980,This was the most recent period of severe financial strain to occur
since the Great Depression of the 1930's. During this time, gold
rallied 2429% higher.
From this peak it then began a cyclical bear market, and proceeded to fall for the next 20 years down
to the 2001 low of $255, a fall of 70% over the two decade period.
During this exact same period stock markets, bond markets, housing and
other asset prices were benefiting from the explosion of cheap credit
and enjoyed some of their greatest rallies ever.
By contrast,
our current gold bull market move is a more modest 752% to the August
2011 peak. So we can see that although it feels like we have had a large
rally thus far, by historical standards we are barely off the starting
blocks.
Next, I want to look at the form that a regular bull market takes.
Lets take a look at the chart below:
It shows the price movement in the Nasdaq Composite Index ( US based
index of Technology companies), from its bull market beginnings in
1980, its peak in 2000 and its subsequent collapse. A few things
immediately become apparent when you look at the chart. Firstly, the
speed at which prices increase accelerates as the bull market
wears on, with the price increases becoming parabolic as we near the end
point. And secondly, the transistions between phases 1,2 and 3 are
seperated by sizable corrections, which at the time feel very much like
the whole bull market rally is over.
This upward sloping curve,
or parabola, is the typical shape and style of a fully-fledged bull
market. It stays roughly the same irrrespective of whether the
underlying investment is an index, commodity, stock, bond or anything
else, and the reason for this is that it is a reflection of human nature
and how we react to greed. The nature of the actual investment itself
is irrelevant, the common theme is the way in which greed manifests
itself, which fortunately for us helps to make it predictable.
If we now look at a chart of the current bull market in gold, we can see
that we are nowhere near the 'blow-off' top that has been witnessed in
prior bull markets, in fact it looks much more likely we are at the
correction seperating phase 2 from phase 3. Also, at the peak we should
be expecting almost everybody to be invested in it, talking about it and
unable to see an end to the rally (the most recent example of this
being the property boom that peaked in 2007). This is clearly not the
case as the overwhelming majority of people don't even consider gold an
investment let alone actually own some.
Having looked at the reasons why I feel the PM's sector has a long way
to go, let us now turn our attention to how you can invest in it.
There are a number of ways to gain exposure to the sector depending
upon an individuals attitude to risk. Lets start at the safest end of
the spectrum.
You can buy physical gold or silver coins( or
bullion) from your National Mint. They will normally offer you a range
of options, the absolute safest being to have them in your possession,
in case of an armageddon type scenario, alternatively you can have the
mint store the physical coins or bullion on your behalf, or lastly you
can own unallocated bullion at the mint, which means that you are one of
a pool of people that own an amount of bullion stored at the mint on
your behalf, but you do not have the right to a specific piece of
bullion i.e. you cannot rock up to the mint and ask to see your bullion, unlike the second option where you do have some specific coins or bullion that you can see.
I would advise everybody to have some exposure to physical gold or
silver, between 5-10% of your net worth. The manner of your holding
really comes down to your own comfort zone, with some people only happy
with the metal in their hands and others a bit more relaxed.
Next, you can buy shares in the companies that mine the gold and silver.
Historically, the mining shares tend to leverage the price movements of
the underlying metal, over the lifetime of the bull market, however
they can be extremely volatile and at times can substantially
underperform. It is for this reason that unless you are someone that is
relaxed about the volatility and doesn't check how your portfolio is
doing every day, they are probably best avoided if you want to have a
long, happy life. If you do invest in them I would recommend taking
possesssion of the share certificates and not owning them through the
nominee account of your broker, and exposing yourself should your broker
default over the coming months and years (and many will).
Lastly, there are financial instruments called Exchange Traded Funds (
ETF's) that trade on Stock Exchanges all over the world. They have
exploded in popularity over the last few years and they allow investors
to gain exposure to all manner of investments that were historicaly
quite hard to trade. As a consequence it is now quite easy to gain
exposure to gold or silver through these instruments. However, the
problem is that although the price of the ETF mirrors that of gold or
silver, you do not have any direct ownership of the gold or silver. The
ETF merely trades in line with it. Also you are exposed to the
creditworthiness of whoever sponsors the ETF, so if they default you may
lose your money.
I currently feel that these ETF's offer decent
exposure to the sector for many people, however there will come a point
in the cycle when they will become too risky and money should be
redistributed into physical gold or silver.
There are other ways to gain exposure, but I believe they are unsuitable to mainstream investors.
To conclude, looking at both historical precedent and general bull
market dynamics I believe we have a long way to run before this current
precious metals bull market has run its course.
That being said, we
are currently in a consolidation that I believe will take both gold and
silver lower before we reach bottom. I think gold will likely reach
$1300, but it is possible that it could go as low as 1150 before the
correction is finally complete, as a result there is no need to rush in
at the moment, simply organise yourself so that when the bottom is
reached you can pull the trigger. As I have stated previously I expect
to see gold at $5000 and silver at $100 an ounce over the next few
years, but at the moment patience is the key.
If you do want to
own some shares but are unsure as to which ones to go for, simply post a
comment at kiwiblackers.blogspot.co.nz and I will add your email to my
specific precious metals bulletin that goes out whenever there is
something of note in the sector, and contains what I consider to be some
of the better buys.
