Should You Own Gold, Silver or Commodity Stocks?

Yet, right now if you are watching the price of gold and silver, it sure feels more volatile. We thank the kind folks at Casey Research for the use of this chart from their worthwhile publication Big Gold.

The precious metals had two dismal days in a row, as all the market forces turned against them, with equities rallying, the dollar moving higher, and oil falling through what was thought to be a pretty secure floor. Friday, oil tried to rally towards $70 but gold is down $25 and silver is down $.44 to $9.21.

In addition, as always, gold gets dumped as the most liquid way to raise quick cash to cover losses elsewhere (or simply to hoard currency during a period that is, to say the least, volatile). Economists at research firm Action Economics report that some hedge funds have been forced to liquidate their positions for just that reason.

Bill Murphy, writing on LemetropoleCafe.com, offers his view of the situation right now: “Demand for physical gold is astonishing and yet the price goes nowhere. The dichotomy between the ‘real’ gold market and the Comex is widening.

The US Government is petrified of gold rising to any degree because of its importance, in that a sharply rising price will shed light on ‘Dracula’ … or the hideous inflationary forces set in motion by Comrade Paulson’s bailout.

Ominously, Murphy reports the following:

Several months ago we received reports that bullion dealers in the MidEast were making it much more difficult for buyers over there. Unfortunately similar reports are coming my way on a daily basis from all over the world that this trend is picking up speed. It appears governments and bullion banks are not banning gold, just making it very difficult to purchase.

Conspiracy or not, there’s no disputing that there is not much physical gold to be had, as many dealers have stopped even taking orders.

JP Morgan said on Wednesday it is raising its price forecast for gold for 2008 and 2009 on expectations investors will buy into bullion as a haven from risk.

However, it is trimming its expectations for platinum, palladium and silver prices on fears over falling demand for the more industrial precious metals.

The bank now sees gold prices at $904 an ounce in 2008, against a previous forecast of $884, and at $875 an ounce next year, up from $854 previously expectated.

"Gold and silver should continue to benefit from safe-haven related interest," JP Morgan added in an emailed release.

Nonetheless the bank revised its silver prices lower, to $15.40 an ounce from $16.10 in 2008 and to $12.30 from $12.50 an ounce next year

In the meantime it's a painful time to be holding commodity company stocks.The latest major deal to hit the buffers is Vedanta subsidiary, Sterlite's (SLT) proposed offer for former U.S. copper giant Asarco which is itself struggling to get itself out of bankruptcy. 

Markets must be having an impact too on the continuing due diligence under way over BHP Billiton's (BHP) proposed bid for Rio Tinto (RTP), although this is not a cash offer.

But what does have to be taken into account here is that anti-trust issues may require a combined BHP/Rio company to divest itself of certain key assets and there is no guarantee of a decent price being able to be achieved for these.  Rio itself appears to have ceased its proposed asset sale programme to reduce its debt after its Alcan takeover, which is an ominous sign of things to come.

But with the majors it probably is not a question of absolute survival.  They have the financial strength to pull through and ultimately benefit strongly.  With the juniors it very definitely is likely to be, in many cases, a futile fight to stay afloat.  The scale of the carnage will depend on how long the loss of confidence in markets persists, but there is currently no end in sight.  

Capital projects will have to be put on hold, and with metal prices diving, those projects which may have looked supremely profitable only six months ago may just no longer be so at current price levels.  Even bulk mineral stocks which seemed to have bucked the trend are beginning to suffer on world markets. 

The gold price, though, has been holding up as a store of value pretty well in comparison with other sectors - although here again the junior gold mining sector stock prices have been decimated - and the credit crunch will be leading to delays and postponements in new project fulfilment.

The big problem for analysts and miners alike is that we are now in virtually uncharted territory. 

This is probably the nearest the current world has been to the 1929 crash.  The loss in confidence in the markets and in governments' abilities to control the devastation is putting the markets under huge pressures and no-one is quite sure where things will end.

At an ICMM reception in London yesterday evening, Richard Adkerson, CEO of Freeport McMoran (FCX), and the new Chairman of the International Council for Mining and Metals after Brad Mills of Lonmin stepped down, acknowledged as much, but also told Mineweb that the industry will cope with the problems as it has with other major eventualities in the past. 

Indeed the slump in prices may well offer spectacular opportunities for those with powerful balance sheets.  Adkerson said at the event that he had spoken with a number of leaders of other top mining companies and all express confidence in the industry's future as he did himself. (He also said he read Mineweb articles virtually every day!)

But while the market crash may provide opportunities for the strong, it is very much the Darwinian theory of survival of the fittest which will prevail.  The industry has seen crashes before which have also resulted in huge contractions in the numbers of junior miners. 

But it always recovers.  The world cannot do without mined minerals.  There are going to be great opportunities out there for the strong and the brave. But how far these companies can drop for now is anyone's guess.

UBS AG said recently that gold probably will peak in 2008 after seven annual gains, and average $825 an ounce in 2009. That doesn't sound too promising and we are wondering why they feel that strongly on the continuing fall of gold.

“The problem that gold seems to be suffering from is fewer-than-normal players,” UBS’s John Reade wrote. “Comex traders seem almost sidelined as leveraged investors hoard cash. Jewelry demand is very slow. Safe-haven buying has slowed.”  A big OUCH for gold owners!

Frank McGhee, of Integrated Brokerage Services in Chicago is not about to join them, noting that “you're seeing some buying coming back to gold on the wall of worry … The underlying problem in the credit markets is going to take a long time to work through.”

McGhee added that it’s no simple matter, though. “It's going to be very volatile, very thin trading, very slippery. But if you look, gold is the strongest asset on the board,” he said.

And Dan Norcini, writing on jsmineset.com, says that all of the recent gold selling is:

FORCED liquidation on account of redemption requests. That has NOTHING TO DO with the real physical gold market where demand remains at unprecedented levels, levels so high that it is producing serious shortages of bullion for would-be buyers.

This is what is producing the increasing dichotomy between the Comex and the real gold market. I would go as far as saying that we are for all practical purposes seeing a BLACK MARKET in gold beginning to develop.

Someone asked newsletter editor Dan Ferris the following question:

I took your advice and purchased physical silver. Being a novice at this I was under the impression that gold and silver were safe hedges against a deteriorating market. Instead of gold and silver rising or even flat lining they are both fluctuating with the market volatility in the same cycle. What gives?

Ferris' Answer:

Gold and silver aren't hedges against a market decline. You should own physical gold and silver not because the market is falling, but because of the cause of the market's decline: a massive credit crisis, which has already resulted in an expansion of the Federal Reserve's balance sheet. Physical gold and silver will protect the purchasing power of your money and not much else.

No wonder gold isn't getting much respect lately. All I can say is if the value of long-term US Treasury bonds can go way up during a horrific financial meltdown and credit crisis, can you imagine what gold and silver might do after all the massive "reflationary" bail-outs and injections of fiat liquidity causes a bit of hyperinflation? Imagine that scenario.

Stock position: Long SLT, FCX.

Comments

[PastTense:]

I don't understand the "not much physical gold to be had" comment. Why aren't individuals just buying gold futures and taking physical delivery?

2008 Oct 19 10:39 AM

[Tom Bombadil:]

Wow, an article about gold that is reasoned, informative, and doesn't sound like some deranged cult leader wrote it. Very nice work.

As for the physical/paper thing, I still don't understand why it is a surprise that prices are higher at retail for small quantities than they are for wholesale purchases in bulk. Why do we need market manipulation conspiracy theories to explain it?

2008 Oct 20 12:23 AM

[NOWHEREMAN:]

Gold, not yet. Silver start nibbling.

Gold bullion has not as yet gone through the same wringer that Gold stocks have.

Silver is down 50% off its peaks and as a perceived industrial metal will rally with any improved outlook for the future.

2008 Oct 20 11:32 AM

[JasonC:]

The answer to the headline question is a flat "no", you shouldn't own any of the three. Gold is just another bubble taking slightly longer to go splat.

2008 Oct 20 12:14 PM

[NOWHEREMAN:]

Monday was certainly an Interesting day:

Stocks up
Dollar up
oil up
gold up

I really would like to return to the good old days when you could count on something.

2008 Oct 21 01:11 AM

[Keer-eh Khar:]

This is not an opinion article, this is a collection of quotes by others with no clear, solid conclusion. The articel ends with "Imagine it"--Huh?
No clear nothing in this so-called article. You fail: "F".

2008 Oct 21 02:45 PM

[Philly Jim:]

I believe the equilibrium for gold prices to be in the range of 780-820 an ounce before demand destruction kicks, same as oil above 110. The thing is though, we also see production destruction now when gold falls below 800 no matter the cost of fuel. Everything seems to be too volatile to invest in right now, this market is disgusting. The only ones that seem to be winning are those closely connected to Bush.

2008 Oct 21 11:29 PM

[TradrMick:]

During a severe credit contraction, all asset classes fall except for bonds. People keep focusing on the government bailouts as inflationary, but they fail to understand that it is more than offset by the massive destruction of credit ( also money supply ) since the great depression.

We are no longer living in an inflationary world.

2008 Oct 23 07:51 AM

[rasimes:]

If you understood short selling you would know that there is a manipulation. Google "Ted Butler." Read all the articles of his you can find. He is the leading authority on the gold and silver market. Any one who is a serious metal's investor knows there is manipulation and it's not a theory. Pressure on the CFTC has finally brought about an investigation.

2008 Oct 24 01:52 PM

[Marketer25:]

Isn't this the fellow who in August wrote "Yamana Gold: A Potential 70% ROI"? Since then the stock (AUY) has fallen 50%. Well, I know we can't get it right all the time but you'd think he'd have some shame and hibernate for a while.

Hmmm...might be worth a punt now though :)

2008 Nov 05 05:40 AM