The difficulty of investing in gold these days is there is a palpable and possibly legitimate fear that gold is in a bubble. Nobody wants to be caught in the bubble when it bursts. Unlike many stocks, virtually any type of direct gold investment has a lot of volatility built into it, which makes trading gold securities difficult. So unless you are a very nimble trader, the real question to ask is whether there is a long-term reason to buy or short gold. Long-term investors who climbed into the metal the last time it rose to historic highs have had to wait 30 years for those highs to be eclipsed.
The long argument is that monetary and fiscal policies of both domestic and foreign governments is destroying the value of paper currency. Economies are getting worse, not better. Thus, hard assets provide a hedge. Gold is a precious metal with intrinsic value. At every hundred-dollar price barrier, someone calls a top and gets hammered on his short.
The short argument is that gold’s price of almost $1,900 per ounce vastly overvalues the metal, and the market is being driven by speculation. CNBC has specials on gold, “we buy gold” stores have opened all over the place, pundits call for $2,500 per ounce of gold, and a bevy of direct ETF gold investments have proliferated. This shows sentiment has become outrageously bullish.
The Central Gold Trust (AMEX:GTU) is a closed-end mutual fund that only owns the hard metal itself, and trades at either a premium or discount to its underlying net asset value. This security has been trading at a significant premium for some time. The same goes for the Central Fund of Canada (AMEX:CEF). That suggests sentiment is forming a bubble.
Charts courtesy of DecisionPoint.com
So, what’s the play?
My feeling is that, if you are a long-term investor, you should have a diversified portfolio that includes precious metal exposure. Depending on one’s risk tolerance, I suggest anywhere from a 1% to 4% position in precious metal exposure. Given gold’s (and silver’s) extraordinary rise, however, I wouldn’t buy your position all at once.
First, I’d spread your risk among several areas that are both direct precious metal investments, and those that are related. SPDR Gold Trust (NYSE:GLD) is an ETF that invests directly in gold, and ETFS White Metals Basket Trust (NYSE:WITE) holds physical silver, platinum and palladium (also at historic highs). A related investment is the Market Vectors Gold Miners ETF (NYSE:GDX), which holds a basket of gold miner stocks.
Finally, I’d buy DGSE Companies, Inc. (AMEX:DGSE), a small company that is undergoing a quasi-reverse merger in which privately held NTR Metals is slowly taking over the company, merging its gold buying/selling and market-making business into DGSE. The company seems poised to make significant earnings from buying and selling gold and making the spread, rather than being tied to the metal price itself.
The key with all of these investments (except perhaps DGSE), however, is to dollar-cost average into them. That way your investment is smoothed across many months.
Lawrence Meyers owns shares of SPDR Gold Trust and DGSE Companies.