I have always been bullish on gold (NYSEARCA:GLD) and I maintain that stance even today when gold is significantly down from its highs. I own physical gold and I will continue to buy gold whenever financial flexibility permits.
I am not alone; central banks are buying gold as well. If one analyzes the gold demand trend for the second quarter of 2014, central banks have been busy buying gold. For 2Q14, central banks bought 117.8 tons of gold with average price during the quarter being $1,288 per oz. Central banks gold purchase in 2Q14 increased by 28% as compared to 2Q13, when the central banks mopped up 92.1 tons of gold with average price during that quarter being $1414.8 per oz. For the first half of 2014, central banks bought 242 tons of gold as compared to 223 tons of gold bought in the first half of 2013.
Very clearly, central banks have been steady in buying gold even as gold prices fluctuate. I believe that this is the best strategy. Investors need to keep buying gold whenever their financial flexibility allows. Investors need to understand that gold is not just an investment; gold is more of an honest currency. Central banks might want to explain why they are busy buying gold as a part of their reserves diversification than buying other currencies.
Of course, just central banks buying gold is not the reason to be bullish on gold. Being bearish on paper money for the long term is the reason to be bullish on gold. US debt to GDP has increased from 62.8% in the fourth quarter of 2007 to 103.3% in the first quarter of 2014. As debt is essentially money in the current system, the amount of paper money has swelled significantly in the US. The same is the case with Europe and China.
Further, total credit in the United States has increased from $51 trillion in the fourth quarter of 2007 to $59 trillion in the first quarter of 2014. No one would question my statement that the 2007 crisis was driven by excessive credit. If this is an acceptable statement, one needs to ask if we are better than 2007 or worse than 2007 when it comes to credit.
With certainty and numbers I can say that the world is more leveraged than we were in 2007 and my conclusion is that we are headed for a bigger crisis in the years to come. Excessive leverage means excessive paper money and the implication is erosion in value of money. It therefore makes sense to be diversified in gold. I am not suggesting that one needs to be 100% in gold. I am also not suggesting that a bigger financial crisis is coming tomorrow. All I want to say is that buying gold makes a lot of sense considering a glut of paper money in the financial and economic system.
When there is excessive money in the financial system, money swiftly flows from one asset class to another. The same is the case with gold. Money was flowing into gold and gold surged to near $2000 levels. With the glut of money then finding other asset classes relatively cheap, money flowed out of gold. But this did not change the long-term fundamentals for gold. As observed above, we are worse off in terms of credit. There will come a time when money again flows into gold as market participants understand that the financial system is just getting worse.
Another factor that increases my conviction on gold is the ongoing geo-political crisis. The Middle-East is in flames and there is no quick solution to an ever expanding crisis, primarily fuelled by extremists. The tension related to Russia and Ukraine is also high and this crisis also has the potential to take a larger form. It is difficult to find countries that are not involved in some crisis or other. I don't want to talk all doom, but this is just a reality. I expect geo-political tensions to remain high and this will support gold prices at current levels even if it is not a big trigger for gold price upside.
On a relook at the World Gold Council second quarter demand trend, it is clear that gold demand remains steady from the jewellery industry, from central banks and from the technology industry. The only slump has come from the investment industry. In 4Q12, when average gold price for the quarter was at a record level of 1,721 per oz, the gold demand from the investment industry was 470 tons. For 2Q14, the demand has halved from these levels to 235 tons.
I would like to put forward the thought that herd mentality in investing is not a great idea. The relatively smart central banks are consistent with their gold purchase, but other investors have turned away from gold. If I were to apply Warren Buffett's investing principal, then this is the time to buy gold rather than avoid the precious metal.
As weakness in the economy emerges after some cosmetic tapering, the central banks will again accelerate expansionary monetary policies and this will boost the demand for gold. After the current period of lull, I see gold again moving higher towards a multi-year rally.
Talking about gold, I would also like to say that some gold mining companies are trading at attractive valuations and investors can also consider buying the gold mining companies for the long term. As gold prices trend higher, gold mining companies will also move up and so will their dividend payout.
I like Barrick Gold (NYSE:ABX) and Newmont Mining (NYSE:NEM) among the gold mining companies. Both these companies have been able to reduce their all-in sustaining cost significantly as gold prices have declined. Both these companies also have a good asset base and are well positioned to grow strongly when gold prices rebound.
Barrick Gold is currently trading at an EV/EBITDA of 6.8 and Newmont Mining is trading at an EV/EBITDA of 5.4. However, if I had to choose one stock for investment, I would prefer Barrick Gold on a relative basis. For the last quarter, the company's all-in sustaining cost was $865 per ounce as compared to $1,034 per ounce for Newmont Mining. Cost efficiency is critical in the industry and Barrick Gold has a relative advantage.
In conclusion, the long-term bull market for gold is still not over. The precious metal has several triggers, which can take it higher. Also, gold is more than just an investment. It is an honest currency and I believe that all individuals need to hold some amount of gold. Physical gold is the best option, but a gold ETF is not a bad option as well.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.