Another Look At Gold And Gold Stocks

Includes: ABX, GDX, GG, NEM, PPLT, SLV
by: AssetInflation

In our August 2011 article "Why Precious Metal Stocks Will Outshine Gold" we stated:

Gold is a great investment asset for the long term and has been that way for thousands of years. The attention paid to gold recently is legitimate and in no way a bubble as some pundits suggest. However, recognizing the value of gold as an investment, does not mean that buying the shiny metal directly is the best way to profit from the emerging long-term bullish trend.

Many factors are involved with establishing a market, and various relationships can be measured against gold to determine which is the best way to invest in the trend. In addition to the physical metal itself; there are ETFs, gold mining companies and sister metals like silver, platinum and palladium. Each relationship should be somewhat correlated to the overall trend with gold itself, however the variations of that correlation can give the investor some very good insight.

The thrust of our recommendation was that Gold had surged ahead of the metal miners and its sister precious metals. Gold had been on a tear (up 30% in the previous 200 days), and the mining companies and sister metals lagged behind Gold's enthusiasm.

GoldClick to enlarge

By looking at the chart above, the recommendation was a winner for most of the period with Newmont (NEM) outperforming the most (up to +30%) and Goldcorp (GG), Barrick Gold (ABX), and mining index (GDX) trading mostly ahead of the metal itself (+5 to 10%). Platinum (PPLT) was considerably weaker (-10 to -20%) and only barely recovered in the recent few months (-5%).

However, if you look where we started, and where we are today, it is almost a complete wash as they have all trended to back to relative parity (0 to -10%) and gold regaining its place on top.

Gold Continuing To Outperform Platinum

We continue to believe Gold's out performance over Platinum indicates fear of currency debasement versus a good play against precious metal demand or supply tightness. As Japan, UK, and European Central Banks have joined the U.S. Fed's printing party, the amount of gold used to "hedge" against currency loss has increased in proportion to the metal used by consumers. If this trend of printing continues, gold will continue to outperform the derivative investments.

Gold Maintaining Performance versus Gold Sector and Large Mining Stocks

We believed that the divergence in August between gold and the mining sector signified a "market belief that the dramatic move in gold is more short term in nature, and thus unsustainable." We were partially right and at the same time wrong. Gold did correct, or more accurately stabilize, however the premium attached to gold has returned to the August 2011 peak. We believe this relatively strong corrective action, and subsequent return to strength, signifies that gold's relative strength is real. It suggests, similar to the platinum trend above, physical gold is being driven by people/institutions that fear future currency debasement.

Outlook: Physical Gold Shines Brightest

We are revisiting our outlook and focus based on information that has continued to evolve (and summarized above). It is clear to us that physical gold continues to be in great demand relative to derivative alternatives, especially considering the apparent need for central banks to support the world economy. As physical gold continues to be accumulated by individuals and governments worldwide, we believe that a premium will continue to be justified.

Therefore, the continued outperforming of gold relative to the mining sector, the large individual miners, or even its sister metals platinum and silver is now likely. The real reason to own gold is the protection of buying power over a sustained period of time, and gold has served that purpose well over many generations. We believe in the true long-term demand of most hard assets, and we also believe that the gold in the ground (miners) or the equally precious metals (platinum and silver) are worth owning. However, at today's current ratios we believe physical gold will continue to outperform.

Pairs Trade Strategy: Long Physical Gold Vs. Short Everything Else

This strategy seeks to profit from the disparity between Gold and other correlated assets. At this time, we are recommending physical Gold over all other forms of ownership. For those investors who use spread trades to maximize this type of differential, the recommendation is as follows:

Pairs Trade Comparison
Long Gold $1645 Short NEM $54.30
Long Gold $1645 Short ABX $43.32
Long Gold $1645 Short GG $44.45
Long Gold $1645 Short GDX $50.12
Long Gold $1645 Short PPLT $164.83
Long Gold $1645 Short SLV $31.26
Click to enlarge

Using a pairs strategy is meant to be a non-directional view of the market. We do believe that the overall trend for gold, the miners, and other precious metals will continue to rise over time. As the central bankers continue to print, the incremental dollars will eventually lead to a severe inflationary environment that should benefit all three investment methods. By focusing on which form of precious metal ownership is optimal at any given point in time, we believe that the forward risk/reward relationship can be enhanced.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.