7 Misconceptions About the Gold Market You Need to Know

by Louis Navellier | November 16, 2013 9:00 am

As you read this, I am knee-deep in gold bugs at the 39th annual New Orleans Investment Conference, held November 10-13 at the Hilton on the Riverfront. I’ve been a panel moderator, MC, or host at this conference for over 30 years. Also in New Orleans, Navellier portfolio managers Michael Garavanta and Michael Borgen are hearing Michael (“The Big Short”) Lewis speak at a FactSet market symposium.

I’m not quite sure what all those Michaels are discussing, but this conflict between two market world-views reminds me of my first New Orleans conference in 1981 when the gold bugs were meeting next to a conference of big bank presidents at the Hilton. I noted some hostile encounters in the hallways as the bankers called the gold bugs “crazy” and the gold investors warned of a coming run on the banks.

Over the years, I have come to see the virtue of both stocks and gold, but I’m still caught in the middle – often literally, as a panel moderator – between a war of words between fans of the stock market and the gold bugs, who often distrust paper-based investments. Still, I am more convinced than ever that there needs to be a truce between the Gold team and the Green team. Both investments have their role.

There is no need for this war of words. A well-balanced portfolio has plenty of room for a large holding of equities and a smaller allotment for gold. Unfortunately, many stock market analysts tend to evaluate gold as if it were a stock.

From what I read in the established financial press, analysts have seven basic stock-oriented objections to gold. They are concerned that (1) gold doesn’t throw off earnings, (2) gold does not pay interest, (3) gold is merely an inflation hedge, or (4) gold is merely a crisis hedge; (5) gold in the last decade was a classic “bubble; (6) gold has little or no practical (industrial) value; and (7) the recent sales or shorting of gold ETFs and futures contracts mean gold will continue to fall or remain flat.

It’s time to look at these seven assumptions about gold with a mutual respect for both stocks and gold.

1) Gold Doesn’t Throw Off Earnings

The major misconception here is that gold competes with stocks, which are often measured by earnings. Gold is more of an alternative to cash, not stocks, but if you want to talk about stocks, they are also difficult to value, since quarterly earnings are subject to a wide variety of usually-wrong guesses by analysts. Stocks constantly disappoint or surprise analysts on the upside or downside. It is difficult to predict any stock’s future performance. And you can also make the “no earnings” argument about America’s most widely-held investment, a home. There is no formula for evaluating the right price for a piece of real estate. Does that mean we should not own real estate?

2) Gold Doesn’t Offer Interest

These days, bank cash typically earns about 0.25%. The Fed’s target rate for short-term interest rates is (and will be) 0% to 0.25% for the foreseeable future. If you want to go out a little longer on the maturity curve, the two-year Treasury note currently returns a microscopic 0.3%. The euro also earns just 0.25%. This is gold’s major competition. Since gold earns only slightly less than bank CDs or short-term Treasury bills, that puts gold darn close to an “even playing field” with cash.

3) Gold is an Inflation Hedge (and there is little or no inflation)

A recent Wall Street Journal article is typical when it says that gold is down because “inflation remains subdued, dimming gold’s allure.” While global policies of monetary expansion will likely lead to more inflation, in time, the main point to remember is that gold does not “track” inflation, but is a long-term hedge against paper-currency value erosion. From Roman times to the present, an ounce of gold could always buy a good suit of men’s clothes. Today, an ounce of gold could buy a man a fine wardrobe – suit, shirts, ties, and a nice pair of shoes. Gold does not track inflation every month or year, but it has historically beat inflation over a lifetime.

4) Gold is a Crisis Hedge

In the October issue of Kiplinger’s Personal Finance, Kathy Kristoff said she avoids gold since “no one can provide a good formula for evaluating the right price to pay. Gold is essentially a hedge against fear. When people become worried about the economy or the value of their currency, they bid up gold’s price. But are they $500-an-ounce concerned or $2,500-an-ounce terrified? I know of no logical way of making that call, so I simply stay away.” Gold is not this one-dimensional, but she is right in saying that gold mostly reacts to severe crises, not everyday run-of-the-mill unrest.

5) Gold is a Bubble Investment

A recent Wall Street Journal survey on gold revelaed that “gold has lost its luster” and it has “lately…been a dud.” Just what do they mean, “lately”? This year, gold is down, but if you want to compare gold’s performance to stocks in late 2013, the precious metals beat stocks. From June 30 to November 1, 2013, silver rose 17.7% and gold rose 11.1% vs. 9.3% for the S&P 500 and 4.3% for the Dow. In the five years after the global crisis of September 2008, silver rose 110% and gold 77%, doubling the S&P 500 in the same five years, so there’s no sense in viewing these investment classes as an either/or choice. A balanced portfolio includes a lot of stocks and a modest gold position.

6) Gold is Inherently Worthless

Gold has been deemed by most civilizations as a superior form of money for thousands of years. Aristotle outlined the four key criteria for money (in shorthand: durable, portable, divisible, and intrinsically valuable) with gold holding superior advantages in all categories. In writing about gold, the Journal doesn’t exactly say that gold is “worthless,” but they did write: “No one knows how to value gold…gold doesn’t generate cash flows. That makes the shiny stuff worth only what the next investor will pay for it.” That’s a negative way of expressing gold’s chief asset value: Gold does not rely on another person’s promises. In other words, gold has no counterparty risk. With stocks or bonds, investors must evaluate if the underlying company can meet its debt payments (or scheduled dividend), or whether the company might even declare bankruptcy, while gold remains gold.

7) Gold ETF Demand is Down

Articles about gold in the financial press invariably focus on declining gold ETF sales or short interest in the futures market. These paper gold investments can indeed wag the dog, but the vast majority of gold demand is for physical metals. Over 60% of gold demand comes from Asia (primarily China and India), but even in the U.S., physical demand is rising. The U.S. Mint recently announced that 2013 sales of U.S. American eagle gold coins surpassed total 2012 sales as of November 1, so they have sold more gold eagle coins in the first 10 months of 2013 than in all 12 months of 2012.

Due to a flat supply curve – with under 2500 tons of newly-mined gold coming on market each year – this battle between short-term paper gold traders and long-term physical gold accumulators will likely continue, miring gold in a $1200 to $1500 trading range – but giving investors time to build a position.

Is there a role for gold in a portfolio? Look a little further..

The “Small” Role of Gold in a Balanced Portfolio

In their November 2-3, 2013 weekend review of the gold market, the Wall Street Journal concluded that “a small allocation to gold won’t kill an investor’s portfolio, but experts say you should think twice before leaning on it heavily.” The authors don’t define what “small” or “heavy” mean, but a “small” 5% to 10% position in gold has protected some portfolios from paper erosion over the centuries. Gold can provide portfolio balance, plus price appreciation in decades like the 1930s, 1970s, and 2000s, when stocks fell.

There’s also the seasonal cycle to consider. A recent Bloomberg study of gold price data from 2002 to 2011 found that gold’s best three months historically came in the final third of the year. November was the best month of the year for gold (averaging 4.42% gains). September comes next and December is #3. Most of this seasonal demand is based on a series of festival seasons in a variety of cultures – Ramadan in the Muslim world, the Indian wedding season, and Christmas in the west. Then, in February, we celebrate Valentine’s Day and the Chinese New Year. For all of these holidays, gold jewelry is a common gift, so jewelry fabricators tend to order tons of gold in the fall to meet rising demand late in the year.

Gold is an alternative to global paper currency debasement and can be portfolio diversifier. With a modest position in precious metals, investors may be able to improve their overall portfolio performance while reducing their risk.

Written by Gary Alexander

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