Shiny Metals, Or Dull?

When it comes to gold, put me in the same camp with James Wolcott from the Vanity Fair blog. I am 100% in agreement:

I agree with legendary value investor John Neff (former manager of Vanguard's Windsor Fund) who said, "Gold isn't an investment, it's an enthusiasm." And when I see how many people are being sucked into gold investments from all those cheesy radio and TV ads (with their overt or sometimes explicit survivalist overtones), I see another bubble being blown that at some sad point will go blooe

I have never had much enthusiasm for gold for a number of reasons:

• It doesn't pay interest or dividends.
• It has no industrial uses.
• It is a momentum play subject to bubbles and busts.

And as noted above any investment touted by G.Gordon Liddy in ads on the Glenn Beck Show gives me pause.

Popular lore touts gold as an inflation hedge. In fact the record for gold as an inflation hedge is at best uneven. The chart in the next post shows gold's real vs nominal price. A separate post illustrates this with an interesting graph.

So other than momentum, what factors might be driving the metal higher (or adding to the momentum other than the masses blindly buying and momentum players jumping on)?

Unwinding of hedges by gold producers: gold producers often sell their production forward to lock in prices. As gold rises these hedge transactions become losers and the gold producers are unable to benefit from higher prices. As the producers throw in the towel on their hedges they need to buy gold. But this is a finite driver of demand, once the hedges are unwound the transactions are finished. On the other hand if the gold price starts to sag the producers will sell again.

Central Bank purchases of gold. In my view this will be a very finite source of demand. As I noted, gold pays no dividends or interest. So consider the central bank of China or any other country. $10 billion (a tiny amount of reserves) put into gold as opposed to US Treasury bonds means foregoing $350 million of risk free interest. That is no small sum particularly when multiplied by 10 or 100.

Interestingly, and to me not surprisingly, while all the breathless voices in the media have been fixated on gold, it is the "boring" industrial metals that have had a much bigger price appreciation. The chart compares the gold ETF (GLD) and the base metals ETF DBB composed of equal weighting of aluminum, copper and zinc. (see lower graph)

I am not in the business of price predictions but in my mind there are several factors connected to economics and not "enthusiasm" that can continue to underpin long term price increases in these metals.

Most fundamentally these are a play on growth in the developing world. You can't do much infrastructure expansion without those metals. The demand will only increase further when the developed country economies show some growth.

Secondly these metals can also perform well as inflation hedges.

Additionally there is a move into commodities as a permanent allocation in many institutional portfolios. In contrast to the flows into gold this is not "hot money". Much of this money is indexed and gold holds a small weight in most of them. The Dow Jones Commodity Index ETN (DJP) for example has gold at 7.5% weight, silver another 2.5%, industrial metals have a 24% weight.

A recent FT article reported:

At a Credit Suisse conference in September, 51 per cent of managers surveyed said they would increase their level of commodity investment to overweight over the next year, compared with 30 per cent now.
Barclays says ETF inflows have been bolstered by a renewed interest in broad-based commodity indices, which can enhance portfolio diversification and reduce volatility.
"The evidence is that investors continue to value commodity exposure for portfolio diversification and as an inflation hedge," says Barclays: "We expect this trend to continue, with commodities continuing to capture a growing share of the global investment portfolio."
Kamal Naqvi, a director in commodities at Credit Suisse, says commodities are now widely recognised as a key influence over returns from other asset classes. "The outlook for crude oil prices is now an accepted driver of future economic growth and inflation expectations," he says.

All that glitters is not necessarily gold. Other interesting ways to participate in this area is through the stocks of the materials producers: XLB is the SPDR of US materials companies, MXI is the global materials iShares ETF. The latter is compared to gold in the lower chart.

Comments

[mbbf49a]

"I have never had much enthusiasm for gold for a number of reasons:

It doesn't pay interest or dividends.
It has no industrial uses.
It is a momentum play subject to bubbles and busts. "

Uhhh...neither does cash (at least the U.S. dollar). When cash ( the U.S. dollar) pays interest ( and when the government stops printing and spending like a crack addict) perhaps my enthusiasm for gold and silver will diminish. Prior to TARP, TALF, Cash for Clunkers, Crack for Junkies, I was remarkably uninterested in gold and silver. Amazing how watching lawyers and bureaucrats mass to destroy the currency focuses the world's attention on the vulnerability inherent in trying to preserve your life's savings in the U.S. dollar. India gets it. The bozo that wrote this insipid drivel doesn't...there are arguments to be made against the precious metals. He's either not smart enough or at least doesn't know enough to make them.

2009 Nov 19 08:24 AM

[Alan Young]

DBB has been an excellent investment for the last 6 months, but now seems to be (double-)topping as the hot money goes for the shiny stuff. The market can be irrational for a long time, so whether or not it makes sense to hold GLD (or bullion), I think it's unlikely that DBB will be outperforming it anytime soon.

2009 Nov 19 11:48 AM

[Phil59]

James Wolcott is now an expert on the wolrd of investing? I don't think so.

2009 Nov 19 12:33 PM

[silver-bug]

Uh huh. I've heard this one before.

I will refrain from making any derogatory comments on your reasons why you don't 'invest', and will instead agree with you on the facts.

Yes, gold is not much of an industrial metal - it has very little industrial use.

That's why I prefer Silver. And I do agree with you that the base metals are potentially better than gold (although not always). That's why I hedge my bets to include the base metal mining companies, as well as other commodities including energy and timber.

2009 Nov 19 03:13 PM

[Ballkan]

Lawrence Weinman
Are you so stupid or it is the stupidity that your clients have to still stay with you?
Show them the chart of the DOW/Gold please. From 44 in 2000 to 9 times now !!!
Who won and who is still winning the investment game ...... not your clients that's for sure.
Just wait till it gets to 1/1 DOW/Gold and they will never call you back, because they will never buy any stocks in their life time anymore.
It was like that before and it will be again !!!

2009 Nov 19 09:51 PM

[Marco G.]

Mr Weinmen,
Granted that the Metals ETF has gained more than the Gold ETF, but the second chart compares an ETF of materials companies to Gold.

Would not a fairer comparison be to gold mining companies?

2009 Nov 22 12:35 PM