By Thomas J. Connelly, CFA, CFP
1) Physical gold demand was not the problem, and has actually increased substantially since April. Indeed, the gold futures market is telling us there is a severe shortage of the metal at this time. The buyers are Asian investors, central banks, and nations looking for a trading currency other than the US dollar.
2) The price of gold is too low relative to the costs of finding, extracting, and refining it. Today’s estimates for the cost of finding and extracting the marginal ounce of gold range from $1,150 to $1,550 per ounce, without compensation for profit or price volatility. The current price of around $1,400 per ounce (up from the low of $1,180 in June) is certainly not too high in that context.
3) Gold mining stocks are at multi-year lows in terms of valuations based on earnings and cash flows. The ratio of the value of the 16 precious metals mining companies in the Philadelphia Gold and Silver Index (XAU) versus an ounce of gold is lower now than after the 2008 market crash.
4) Foreign governments continue to respond to the credit crisis by running fiscal deficits, increasing debts, and creating money to purchase government debt—thus far with our consequence.
5) The US and Japanese central banks have unofficially/officially announced inflation targets of 2-2.5%—which will devalue the currency and fixed income investments—if they can manage the inflation genie once it is out of the bottle.
6) Gold mining stocks are extremely attractive. The ratio of price to corporate cash flow for gold mining stocks in the aggregate is lower than any time over the last 25 years. Gold mining companies, according to Tocqueville, have had their share prices hammered so low that valuations in terms of price/cash flow are at 25-year lows.
7) Gold is an important portfolio investment and diversifier and store of value. Claude Erb and Campbell Harvey of the National Bureau of Economic Research point out in a recent paper, The Golden Dilemma, that all of the gold ever mined would make a cube approximately 69 feet per side, and equate to around 9% of the world’s stock market capitalization. About half of that is in the form of jewelry, so the share held by investors and central banks is equal to about 4-5% of world investment wealth.
8) Gold has been a store of value to human beings for millennia. Erb and Harvey also point out that the pay of a legionnaire and centurion in the time of Augustus in terms of gold was approximately 41 ounces of gold, and the pay for a private and captain in the US army in terms of gold today is around 39 ounces of gold. This is remarkable stability over more than 2000 years. Over that time, countless currencies, many empires, and thousands of commercial enterprises have failed, but gold as a store of value has endured. The price of Apple stock has also declined dramatically from its highs, but as a technology company there can be no certainty that Apple, or any other commercial or governmental entity, will exist in its current form, much less sustain its current earnings or purpose, over the next 20 years.
9) We do not believe that the philosophy of central planning through the world’s central banks will be successful in the long run. Past failures of systems that emphasize top-down planning and control of prices, such as Marxism, Communism, and Socialism bear this out. Why citizens of the world have learned this lesson but still search for saviors in the leaders of the world’s central banks is beyond me. Four central bankers control 70 percent of the world’s currencies. While we believe they have successfully navigated us through the credit crisis of 2007-09, they bear a large portion of the responsibility for getting us into that mess in the first place—and we have yet to experience the unintended consequences of their cures.
In Summary
Even though a remarkable, long-term store of value, gold admittedly has little long-term investment value. It does not produce income, rents, or other tangible benefits. It is a statement that investors today are uncomfortable with the unfettered faith put into today’s central bankers; that they are uncertain of the consequences of global money creation and debt accumulation the like that the civilized world has never seen before; and that you don’t get something for nothing and we are all afraid and uncertain on how the consequences of all of this plays out.
Gold comprises a meaningful proportion of the world’s wealth, and is a proven store of value throughout recorded human history. Its worth as a store of value has been repeatedly proven through crisis and monetary debasement throughout history in many contexts and in many nations. The conditions for crisis in the developed world still exist, and at least two of the world’s largest central banks have explicitly announced a policy of conscious debasement. Recent market events concerning gold coincide with the strength of the dollar and increasing comfort with the cult of the central banker…yes, the same bankers who got us into a mess in the first place. A small portion of the portfolio should be reserved as insurance for the possibility that they are wrong.
Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Versant Capital Management, Inc.), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Versant Capital Management, Inc. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Versant Capital Management, Inc. is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. If you are a Versant Capital Management, Inc. client, please remember to contact Versant Capital Management, Inc., in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Versant Capital Management, Inc.’s current written disclosure statement discussing our advisory services and fees is available upon request.
