With the recent plunge in gold prices, there is a flurry of articles discussing the nature of the gold bubble, and knocking it and other precious metals as investment options. Specifically, Paul Krugman writes in an article entitled "Gold Does Not Glitter," published in The New York Times, that the gold crash will finally "bring intellectual capitulation" and that advocates of gold have been greatly misled about the soundness of gold as an investment.
In the Wall Street Journal article, "Gold Sinks into Bear Territory," author Christian Berthelsen quotes Stephen Klein, a portfolio manager at New York hedge fund AT Global Capital, when he writes that "Gold has always been sentiment-driven, and now the price action shows you that sentiment has changed." Gold is not sentiment-driven however; it fluctuates inversely with the strength of national currencies such as the dollar and euro. Berthelsen continues, and quotes gold strategist John Paulson of Paulson & Co., when he explains that "Federal governments have been printing money at an unprecedented rate. It is this expectation of paper currency debasement which makes gold an attractive long-term investment for us." Paulson is right.
What is Going On?
The two main reasons for holding gold - as a currency alternative and inflationary precaution, are sound reasons to maintain gold in your portfolio. In order to understand the validity of this claim we look to the housing market to see how gold fares in comparison to the U.S. dollar. According to the government census page on historical house prices, the median house price in 1975 was roughly $40,000. Using gold's historical values, let's say $200 per ounce in 1975, it would take approximately 200 ounces to purchase this house. Right before the 2008 downturn, the median housing price was $240,000 - a six-fold increase in price for what is presumably the same house. At $1000 an ounce, almost the same amount of gold (200 ounces) can buy this same house.
Gold should not be considered in a bubble right before the 2008 downturn, as it is most heavily invested in when the U.S. dollar is doing poorly; the U.S. dollar was obviously the strongest right before the downturn. The 2008 crisis brought with it massive quantitative easing and government bailouts that led to a lack of confidence in national currencies. This in turn fuels speculation for alternatives (precious metals). For this reason, since 2008 gold has seen almost a two-fold increase in its value when it reached its all-time high of $1900 (August 2011).
Suggestions for Investors
There is a clear trend existing for gold that results from monetary policies and confidence in currencies. We see the greatest fluctuations where consumer confidence is low and inflationary expectations high, thus producing "inflated" gold prices above their natural levels. When the correction process takes place and values adjust, the gold price will fall to a normal level, and should not be identified as a failed investment.
Companies involved in the exploration and holding of gold - Randgold Resources Limited (GOLD), Barrick Gold Corp. (ABX), Newmont Mining Corp. (NEM), SPDR Gold Shares (GLD), and Goldcorp Inc. (GG) - all follow the market trend we set out in the previous section - steady upwards until the 2008 downturn, then a rapid price hike because of increased government spending.
The following is a chart that reflects the recent decline in these stocks that is likely to continue until a natural level is reached:
Monday's Closing Price
Randgold Resources Limited
Barrick Gold Corporation
Newmont Mining Corp.
SPDR Gold Shares
Though these stocks may be down, they are certainly not out. They are part of one of, if not the most consistent, commodity industry in terms of valuation, and will continue to grow after the adjustment process.
Randgold offers growth through continual exploration and development of mines west and central Africa, while Barrick was notably overvalued for a while and was bound for an adjustment period. It has strong revenue growth and good cash flow from operations and will look to be a continued supplier for gold exploration. Following the trend as well, Newmont Mining Corp is another company that has been overvalued. It has a history of having a fair balance sheet and trying to reduce costs while trying to expand operations. Ranked as the number two gold producer in the gold industry, it will continue to grow as part of the industry.
SPDR, a gold ETF, suffers as the government engages in quantitative easing propping up confidence in currencies. As history shows however, there will be continued fluctuation due to government spending, and SPDR will look to benefit from decreased confidence in currencies, making it a viable investment option to hold onto. Goldcorp, according to Motley Fool, is one of the leading players in the gold mining market. Its low-cost structure over the past several years has made it a very sought after investment opportunity within this industry.
Companies in the gold industry have been artificially driven up as the government exercises massive quantitative easing as a preventative measure against deeper economic downturns. Producers of gold and ETFs have always experienced steady growth and held its real value against national currencies. Gold should certainly be considered to be a part of one's long-term portfolio, but never an opportunity to capitalize on speculations due to the uncertainties involved with government policy. What has been happening in the recent days is the correction in gold prices as the economic crisis around the world is steadied, and should not be seen as some final revealing of gold as a bad investment - gold will always be a sound investment.
Additional disclosure: By Andrew Deckert