Gold Stocks: Why It's All About the Bottom Line

Managing your own investments can be either one of the most rewarding or the most frustrating experiences you’ll ever have. Investing successfully is like becoming successful at most everything else. It takes a good bit of time and a willingness to learn. It takes a good bit of humility, if not, you’re going to learn a bit of humility. Basically, it’s not easy.

Over time though, achieving financial independence in exchange for riding out the ups and downs, buying when no one else is willing to, and taking the time and exercising patience is truly worth it. And that’s the key. It’s what investing should be all about. There are few things you can do that will give you an opportunity to grow a fortune large enough to be able to do whatever you want whenever you want. Of course, there’s a price. In many cases…a big price. Winning in the stock market involves a lot of things, but the most important thing is to truly learn from your mistakes. I know, boy, do I know, and that’s the toughest part.

I’ve had quite a few jobs over the years and I’ve worked with 1,000’s of different people from dozens of different companies from Fortune 500 manufacturers, warehouse operators, shipping and transportation companies and even a few engineering firms. For the most part, I’m a pretty understanding guy. People make mistakes; I know I certainly have made a few.

The thing I can’t stand (and something I’ve watched destroy people’s life savings) is making the same mistake twice. In a bull market, you can get away with it. When oil prices were raging and everyone was banking 20% to 30% a year on oil stocks, you feel like an oil expert. However, when everything stops going up, mistakes are much more costly. That’s why I’m frustrated with what I did at the end of last week. I made the same mistake I do every few months - I talk about gold.

The Middle Ground is a Lonely Place

On Thursday, I felt it was time to answer the question, is Now the Time to Buy Gold? Normally, I try to avoid the topic for many reasons. If you say gold is going to the moon, a legion of supporters and detractors will arrive. If you say, it’s going to stay flat or go down, the supporters inevitably become detractors and vice versa.

I’ve never seen anything, which strikes such a strong emotion in investors like gold. You either love it or hate it. At the extremes, the most ardent gold permabulls refuse to accept any plausible reason gold could go down. Those who consider investing in gold to be a futile endeavor, refuse to accept the long-term case for gold. The confirmation bias is very strong. When it comes to gold, the middle ground is a lonely place. That’s why I always consider it a mistake to write anything about gold. Every few months, however, I’ll always take advantage when I see an opportunity forming in gold and gold stocks.

This time around though, I wanted to make an effort and let everyone know a potential opportunity in coming up in gold and gold stocks. I want to clarify one important thing about the way I’m looking at gold right now.

It’s All about the Bottom Line

Over the past few years, gold has had its ups and downs - just like anything else. In a market like this, gold is forming a nice trading band, which results in a fairly low-risk way to accumulate a lot of gold and gold stocks for practically nothing.

Gold has held up relatively well throughout this crisis and has developed a strong trading band. The lows are around $700 an ounce and the highs between $900 and $1,000. When gold was around $800 an ounce, we were in the middle of the road. Over the next year, it wouldn’t surprise me to see gold at $1,000 an ounce. I also wouldn’t be too surprised to see it at $600 an ounce.

I can’t see the future…no one can. However, I can make a prudent investment with the risk/reward ratio in my favor. For instance, let’s say gold is going to either $1,000 or $600 per ounce. That’s a pretty rational bet given the current volatility and the strong buying on dips and selling at highs. So for my investment dollar, I’d much rather buy at $700. That way I risk a 14% loss (selling at $600) to make a 42% profit (selling at $1,000). It’s far superior move when compared to buying at $800 an ounce and risking 25% to make 25%. That’s why when investment capital is in short supply and the price of everything is falling, I’d much rather be patient, wait for the opportunity, take $10,000 and buy 14 ounces of gold than rush out and buy 11 ounces when gold is running up.

So when, and if, gold gets to $2,000, I’ll be able to sell the gold for $28,000 instead of $22,000. I’d rather wait for an opportunity to keep the downside risk as low as possible and have an even bigger payoff. That’s the key to investing successfully.

Gold Stocks for Free

Although I always ensure I look at investments with a strong focus on risk and reward, I can’t help but take advantage of opportunities when I see them. Right now, it looks like a very good one is coming up in gold.

When gold hits the extreme price points – which we’re very close to - odds are it’s a pretty good time to buy - and, I will be buying. On the flipside, I’ll be selling when gold hits $900 an ounce.

I won’t sell out completely. I just take my initial investment capital out. For instance, if gold hits $900 an ounce and shares of Barrick Gold (NYSE:ABX) hit $30, I’ll sell two-thirds of the shares I bought at $20 leaving me with a decent sized position with a cost basis of zero. The shares I do have, I’ll have for free.

I do this and encourage others to do it because, frankly, I don’t know if gold is going to $2,000 or $3,000 an ounce. It could, but it also could fall right back to $700 an ounce and bring gold stocks down with it. If it does, I’ll buy again and go through the whole process once again.

I’ve learned to love volatility and range-bound markets. I’m not an active trader, but there are long sweeping moves which last months at a time. If you’re patient and look at what’s going on, you can amass a sizable position, literally, for free. That way, if gold does take off, I’ll be there going along for the ride, and if it doesn’t and gold goes the way of every other commodity, I wouldn’t have really lost a dime.

Here, at the Prosperity Dispatch, we consider that a pretty good way to invest.

Disclosure: None

Comments

[Pipo:]

Jim Rogers is buying Gold. He thinks all paper money will be devalued and that we will have massive inflation in the future.

jimrogers-investments....

2008 Dec 07 12:14 PM

[Dean Plassaras:]

Actually, as stated AM's position makes a great deal of sense.

2008 Dec 07 01:04 PM

[Kelly Liebe...:]

Actually, a decent strategy for most investments, all things being equal...

When the FDIC gets into the "marketing" game by trying to calm investors fears of bank failures by "insuring" deposits up to $250,000, I would say that is the entry point for gold.

Unfortunately, the FDIC does not have enough money to insure even a portion of all deposits currently in banks - not at $100,000, or magically now at $250,000. It is a marketing ploy to make you feel secure.

Many people are seeing right through this sham and and are employing new strategies for their money. Gold is a safe haven in a very uncertain time. With over 500,000 more people unemployed in November and the ripple effect just beginning, the tsunami has not hit yet. It only picks up speed and intensity from here.

I would urge everyone to make some economic disaster plans pretty rapidly.

2008 Dec 07 01:34 PM

[De Graaf:]

A very prudent way of investing Andrew.
Let's make some money together in the coming bull.

brgds

2008 Dec 07 02:46 PM

[adan:]

very nicely said:

"I’d rather wait for an opportunity to keep the downside risk as low as possible and have an even bigger payoff. That’s the key to investing successfully." -

i just need to remind myself of it rather frequently :-)

2008 Dec 07 03:50 PM

[Roger Knights:]

I think 750 is the new 700, and 1000 is the new 900. I hope we'll know in two months. Anyhow, that's how I'm betting.

2008 Dec 07 03:52 PM

[Roger Knights:]

PS: I should have said, 950 is the new 900. 1000 is a stretch.

2008 Dec 08 01:45 AM