Two weeks ago, a friend invited me to spend a week sailing around the British Virgin Islands on his new boat. (As you might expect, it wasn’t all bad.)
Onboard was another friend of his, a retired business owner, who told me something surprising. He has 100% of his investable assets in gold stocks.
I looked away and tried to clear my throat inconspicuously…
Turns out he’s been reading a famously bearish market commentator who has been telling him for the last two years to dump stocks and bonds and buy only gold and gold shares.
[ad#Google Adsense 336×280-IA]As market timing goes, it doesn’t get much worse than this.
Moreover, this gentleman had no idea that this same “analyst” has been giving the same advice for, oh, the last 35 years or so.
He is the original broken clock.
But he does make sure to update his foregone conclusions from time to time with fresh facts and figures.
While it’s risky – not to say completely nuts – to have all of your money in gold stocks, or any single asset for that matter, the prospects for gold shares are looking better, even though gold itself remains a question mark.
For the 12 years between 1999 and 2011, gold put on a furious rally, rising fivefold. The last part of that rally was due to fears that the Federal Reserve’s hyper-accommodative monetary policy would result in surging inflation. Like so many prognostications based on economic theory, it didn’t pan out. Inflation remains negligible in the U.S., and Europe faces potential deflation.
Inflation hawks have seen little to get excited about lately. Commodity prices are down. Labor costs are stagnant. And cheap imports are holding down prices here at home.
As I write, gold is down 32% from its all-time high of nearly $1,900 set in August 2011 – and is down 7% since its peak this year in mid-March.
For the last three years, I’ve been warning that as much as 40% of the gold trade has fallen into the hands of institutional investors and hot-money traders.
Unlike mom and pop investors – who tend to think of gold as an insurance policy – these folks won’t sit on dead money for long.
And, sure enough, according to the Commodity Futures Trading Commission, hedge funds have cut their net bullish bets on gold by one-third in the past two months.
On top of this, the World Gold Council warns that demand in China, the world’s biggest buyer of gold, is waning. An association of Hong Kong jewelers reported last week that gold purchases in China are off 30% from last year.
That doesn’t mean you should sell your gold. I’m a firm believer that the price of the barbarous relic is utterly unpredictable because valuation is so difficult. Gold accrues no interest, pays no dividends, generates no earnings and provides no rental income. So there is no price/earnings ratio, cash-flow analysis or yield to maturity.
Rather, think of gold as the spare tire in your trunk. If everything else goes wrong, you’ll be glad you have it.
And gold shares, in my view, are a screaming buy from a long-term perspective. Take a look at this chart:
As you can see, gold shares have fallen twice as hard as the metal over the past two years. This has opened up a valuation gap between bullion and mining stocks. And the investor who buys assets the cheapest tends to benefit the most when the trend turns around.
Gold stocks led on the downslide and they are likely to lead again when gold rebounds. History shows they act as a leveraged play on the metal. A 10% increase in gold often leads to a 30% to 40% increase in gold shares. Plus, you can collect dividends rather than paying storage costs.
In short, gold shares are one of the few asset classes that are undeniably cheap right now. That bodes well for future performance.
Source: Investment U