Gold And Gold Miners Should Rise After The Next Round Of Sovereign Bailouts

Includes: ABX, GDX, GLD, NEM, SPY
by: Zvi Bar

As Europe contemplates yet another round of stimulus, investors may want to again consider an investment in real money. And as J.P Morgan, the man and not the company, once put it:

"Gold is money. Everything else is credit."

Over the last decade and going into 2012, gold had appreciated each year, though it has stumbled recently. The chart, below, highlights the yellow metal's consistent growth since the financial crisis began, and its recent heightened volatility:

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Such volatility is not necessarily a bad thing for the longer-term investor. Gold has not simply declined over the last twelve months. Gold has fluctuated, often violently, during the shorter term, and this may be a sign that gold is ready to make a substantial move, up or down. Years ago, it would have been unheard of for gold to move twenty dollars in a day, but these days it has become a regular occurrence, with the commodity occasionally even moving more than fifty dollars in one day.

These new larger moves indicate that gold has become more comfortable with its higher price and the more substantial relative moves that should correspond with that price range. Additionally, today's dollars are not the same dollars that were used to measure gold even a few years ago. Further, while U.S. buyers compare gold to U.S. dollars, European buyers must compare it to the euro, at least for now, and it is now more likely Europeans who could look to hold their own reserves rather than waiting for their esteemed leaders to devalue their currency.

If you think that governments will print more money, bail out more banks and attempt to keep schisms from deconstructing unions, then you may not feel comfortable holding your money in paper. Right now many leading governments are acting as though they intend on keeping inflation in check, but that may be far easier said than done once the next round of bailouts begins. And that is one advantage that gold has over a currency. Gold can go down in one currency while going up in another, and so when buyers from one country exit the gold shop, buyers from another country enter it.

Right now, European citizens should be building up their gold reserves in advance of probable devaluation of the euro or potential exiting of the union by their country. Cash is rapidly being pulled from the banks of troubled nations, but keeping all that cash in a mattress is probably not the best option for those wary Europeans. At least a few must be buying gold now, and others are likely to follow suit.

And recently, gold has begun to again perform, as investors place their bets and fund their reserves. Over the last month, gold has appreciated by 5.41 percent as investors retreated into it, versus a relatively flat performance by the S&P 500. Additionally, gold miners, which can be seen as a leveraged bet on gold, have largely appreciated by considerably more. See a 1 month comparison chart of the SPDR S&P 500 Trust ETF (NYSEARCA:SPY), SPDR Gold Trust ETF (NYSEARCA:GLD) and Market Vectors Gold Miners ETF (NYSEARCA:GDX):

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The chart also shows that gold and the miners generally moved up when the S&P 500 moved down, and vice versa.

There could be many reasons why these miners have so substantially outperformed recently, including that they had substantially underperformed gold for years, and especially so over the last few quarters. Miners used to be the only real way to gain equity exposure to gold, but since the advent of GLD, many prior would-be investors in the miners have instead opted for the ETF. This resulted in lower trading volume and general demand for miners, but such characteristics are also sought out by longer-term, value-oriented investors.

Beyond their prior underperformance, another reason for their recent strength could be that several large-cap miners provide a dividend that beats the average interest rate available on a savings account, and possibly even a 10-year U.S. Treasury. Miners such as Barrick Gold (NYSE:ABX) and Newmont Mining (NYSE:NEM), among others, offer both competitive yield and potential leveraged exposure to gold appreciation.

Notable differences between miners and gold exist, including that mining companies may suffer risks that a commodity investment cannot, such as political risks, mine productivity issues, bad weather, management negligence, fraud and old-fashioned bad luck. Mines are sometimes shut down by hostile governments, bad weather, an earthquake and many other foreseeable and unexpected risks.

After Europe resolves its issues, and however it does, the United States has its own problems to work through, and that too has the potential to move gold higher. Last summer's debt ceiling debate ended in up shaking up the markets, and resulted in a U.S. treasury downgrade. Given present spending, the nation should bump into the debt ceiling towards the end of 2012. That may cause U.S. dollars to devalue, much like the Euro has over the last few weeks, and prompt U.S. buyers to return to the gold store.

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