Most investors react to market uncertainties by moving their investments from equities to safe havens such as treasuries, the US dollar or gold. Although gold has lost some of its sheen of late as a stable store of value, there are more than a few compelling reasons to consider owning the precious metal right now. However, traditional ways of investing may not be suitable at present, and which is why, through this article, I recommend three alternative forms of investment for the same.
Stock Market Selloff Fears
With S&P 500 (^SPX) and DJ Industrial Average (^DJI) trading at their all-time highs, and Nasdaq Composite (^IXIC) closing in on its peak formed during the dot-com bubble, there are significant fears of stock market correction among the investors.
Many [1,2,3] market analysts are predicting a correction, citing reasons such as contraction in US GDP during Q1 2014, cost savings concerns, share buy-back activity spurred by low interest rates, pessimistic sentiment indicators, P/E multiples expanding faster than earning growth rates, and the list just goes on. Whether these concerns are valid or not is a story for another time, but the continuous bearish commentary has the investors worried and cautious about a market downturn, so much so that they are ready to sell off their stock holdings even at the slightest hint of a correction. In doing so, they might trigger a significant selloff, possibly artificially, and subsequently look for alternate investments. A safe haven store of value, such as gold, would have surging investors' interest in such times.
Need for Diversification
Irrespective of how one chooses to play market downturns, it's best to keep the assets allocation in line with individual risk level. With selloff fears looming in the background, it would be wise to put together a well-diversified portfolio so as to reduce portfolio volatility. And in the absence of an established safe haven asset besides bonds and the US dollar, investors are likely to flock to gold in stressed market conditions. As a result, allocating a small part of your portfolio to gold may help reduce portfolio volatility. Historically, gold has the tendency to move independently of other markets. So if stocks or bonds were to zig, then gold is likely to zag, which would reduce the net effect on your portfolio value.
Contrarily, even if gold were to finish the year at $1,050 (as predicted by Goldman Sachs), it still warrants a 5%-10% allocation to the yellow metal. So in the worst-case scenario, you would still lose about 1% of your portfolio value to gold devaluation. However, further devaluation would in most likelihood be a positive for the stocks held in your portfolio, thereby canceling out or exceeding any negative effect from held gold.
A rule of thumb in investing: Never fail to buy an asset at or below its replacement cost. At roughly $1,250 per ounce, gold almost sells at an average production cost of $1,200.
For years the gold industry's cost reporting standards have been embarrassingly inaccurate and misleading. The industry has always used non-GAAP measures to report its production costs, and like any other non-GAAP measure, they are open to interpretation.
Up until the recently introduced 'all-in sustaining cost' (AISC) measure, the industry used 'cash costs' that included all basic mining costs but disregarded sustaining capital (which increases as mines get older and grades decline), general and administrative (G&A) expenses and various other details. The costing measure became increasingly absurd with each passing year. For instance, as recent as 2010, Agnico-Eagle Mines (NYSE:AEM) was claiming 'negative' costs, after byproduct credits, at some of its mines. You read it right, free gold, huh!
Despite loss-making projects, many gold miners claimed surprisingly low cost per ounce and yet halted projects due to poor returns. Clearly, there was a need of a fix to regain credibility with investors and analysts. Eventually, the World Gold Council came up with AISC-which apparently has its own limitations.
The AISC factors in sustaining capital and G&A expenses, but doesn't include project capital, dividends, taxes and interest expenses. As a result, AISC doesn't show the complete picture either. Some of the biggest names in the industry are debt-heavy, and if we were to figure in interest expenses, dividends, taxes and other capital expenditure to their AISCs, most of them would be underwater or barely making any gains at all. Additionally, a lot of these miners are targeting high-grade mines to increase productions and generate strong revenues even at low gold prices. However, this cannot last for too long, as high-grade mines will face depletion at some point and when they do mining will get expensive.
According to an article by Reuters, the average cost of production was said to be around $1,200 per ounce in 2013. With no fundamental likelihood of weakness in demand for gold and possible supply-side issues in view of production cut-downs, gold seems gravely undervalued at current levels.
Non-USD gold ETFs
Considering the above-said factors, I strongly recommend investment in gold between 5 to 10 percent of your portfolio value. However, I am against traditional investment methods. Instead, I urge investors to consider the following three hedged ETFs for investments in the precious metal:
- AdvisorShares Gartman Gold/Yen ETF (NYSEARCA:GYEN)
- AdvisorShares Gartman Gold/Euro ETF (NYSEARCA:GEUR)
- AdvisorShares Gartman God/British Pound ETF (NYSEARCA:GGBP)
After starting in equities, the new and fast-growing hedged ETFs have infiltrated almost every asset class and grown over 10 times to $15 billion since the beginning of 2013. In February, the AdvisorShares Gartman launched the above-mentioned gold ETFs that invest in gold futures, betting that gold's price will rise, while shorting respective currency futures. For instance, in case of GYEN, the ETF utilizes the Japanese yen to fund its gold position.
For investors that normally buy or sell gold in US dollar terms, GYEN seeks to neutralize US dollar risk. One of the major advantages of holding gold in a non-US dollar-denominated currency is it helps in limiting the downside risk during stressed market environments, where the US dollar becomes a safe haven store of value. For that reason, sometimes other currencies depreciate more than the US dollar and provide better returns in comparison. Let's consider an example.
As illustrated in the chart above, gold in US dollars was down around 27.3% in 2013. Similarly, SPDR Gold Shares (NYSEARCA:GLD) ETF was down 28.3% last year, but gold in yen was down only 11.7% because yen lost 21.48% of its value against the US dollar. Owing to the Fed's stimulus taper, the US dollar sharply rose against all major currencies, and gold wasn't an exception. As a result, the devaluation of gold appeared larger than it actually was.
If we were to consider an opposite scenario, where stock markets declined across the globe, the stressed market conditions would probably cause investors to park their funds in safe havens. Considering that the US dollar is one of them and gold another, the rise in value of gold will be more significant in other currencies.
AdvisorShares also rolled out a gold/British pound and gold/euro ETF to allow investors to build positions in gold in those currencies. All three ETFs trade on the NYSE Arca Exchange, and can be easily bought or sold throughout the trading day. They charge 0.65% in expenses and are tax efficient, as they are not subject to Unrelated Business Taxable Income (UBTI) nor will trigger a Schedule K-1, a feature in commodity-linked investment.
An investor should always try to preempt all kinds of market risks. Already in the fifth year of the stock bull market, there are considerable selloff fears that can easily trigger a panic reaction from investors. Therefore, having a diversified portfolio with exposure to gold and other safe haven investments would considerably reduce the volatility of your portfolio. Needless to say, gold seems undervalued at current price levels, especially considering possible supply-side issues in future. So taking everything into account, along with the Fed's impending rate hike decision, investing in gold through non-US dollar-denominated currencies would turn out to be a risk-neutralizing, and thereby one of the most beneficial investments you would make in the long haul.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.