Gold - The Biggest Risks Are The Ones You Don't See

by: Paul Price

Extensive money printing (QE programs) has led many traders to stock up on Gold via ETFs, ETNs, physical coins & bars and through shares of precious metal mining companies. The urge to own hard assets in a soft money environment makes sense on an intuitive basis.

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The first two of those statements appear indisputable. Is gold really an inflation hedge? That is subject to debate.

Gold peaked in 1980 at about $850 per ounce. Gold bottomed in 2000 near $250 per ounce. Annual inflation in the early 1980s was running in the double-digits. The 1990s calmed down but still saw significant price increases during each and every year.

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CPI (1980 to 2000) inflated by a cumulative 137.24%.

Gold decreased in price by 70.58% (from a high of $850 to $250).

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Underperforming by a factor of 207.82% over a 20-year period would strain the patience of even the most ardent "Gold is an inflation hedge" advocates.

When Gold touched its 1980 high pundits were calling for $2,500 - $3,000 per ounce. 32 years later they're still waiting. We have been hearing $5,000 - $10,000 numbers thrown around recently. Will those predictions prove more accurate? Only time will tell.

Betting on Gold to hold value versus "full faith and credit" fiat currencies does seem appealing. What are the hidden problems with employing at least some portion of your portfolio in this way?

Recent history shows at least some custodians of warehoused Gold proved to have been "unreliable." Commodity brokerage firms MF Global and Peregrine Financial each failed miserably in protecting customer interests in physical gold "safeguarded" by these previously well-respected firms.

If you correctly bet on Gold going up you still may never even see your original stake returned, let alone any paper profits. Speculators were willing to risk price fluctuations. They were not aware they were also subject to outright theft of their property.

Many traders today play Gold movements with ETNs (Electronically Traded Notes) without knowing these have bigger risks than simply metal price action. These ETNs are unsecured obligations of their issuing financial sponsors.

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It's no surprise the list above was compiled by issuers of safer Gold ETFs (Electronically Traded Funds) like (NYSEARCA:IAU) and (NYSEARCA:GLD).

Physical delivery of Krugerrands, American Eagle gold coins and or bullion bars and holding them in your own safe seemed to avoid the custodial problems. Now, word from confirms that Chinese companies have been actively promoting the sale of assorted counterfeit gold plated items "for legal purposes only."

See here and here for the original articles reporting on this very disturbing practice. The fakes are of such good quality that even professionals have been fooled.

Worse still, it calls into question the authenticity of every existing coin and bar in both private and even government vaults. The only way to confirm purity is to open the packaging and drill into the cores of each and every individual item.

This is expensive to do and decreases the value of the underlying gold even if everything checks out. Who will buy your personal stash without knowing for sure if it is the real thing?

The known counterfeiting of well-respected gold coins and bars has now forever damaged the ability to sell gold without huge, value-sapping authenticity testing.

I used to favor shares of international resource and mining companies as a safer, liquid, back-door play on rising inflation. Worldwide political forces and heavy government debt have been catalysts for repudiation of long-term contracts and unilateral nationalization of foreign assets. This puts downward pressure on the earnings power of resource companies with significant assets in less developed countries.

Argentina-based oil company YPF (NYSE:YPF) lost about half it value overnight some months ago after local authorities basically seized its assets without fair compensation. Indonesia has threatened to abrogate signed contracts with FCX because it now wants bigger royalties than previously agreed to. Australia is raising taxes dramatically on BHP, which cut back on its development there in protest.

The good old days of paying contractually promised royalties to less developed nations while mining their natural resources appears to be coming to an end. This explains what look like bargain prices on industry leaders like BHP Billiton, Rio Tinto (NYSE:RIO), Freeport Mc-MoRan (NYSE:FCX), Newmont Mining (NYSE:NEM), American Barrick (NYSE:ABX) and others.

All forward estimates may be shot to hell in the political climate that looms just over the horizon. For mining companies with overseas operations, past performance may no longer be a good gauge of future profitability.

For the individual investor Gold is looking a lot less attractive than it might have originally presented itself.

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.