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  • Thinking about Gold as an "Investment" 0 comments
    Mar 31, 2011 10:10 PM | about stocks: CDE, ANV, GDXJ, SPY, SLV, GLD, DGP, DZZ, KG, GDX, SGOL, IAU, ABX
    Without question, gold is a hot topic and everyone has an opinion.  Is it going up to $2,000, $5,000 or even $10,000 an ounce or is about to plumment back down.  Theories abound about ratios and rationales and arguments.  Some people call it a bubble and others think it could be 10x its current price.  Gold has captivated people throughout the ages and continues to captivate them today.  Most recently, gold was $1,432.70 an ounce for the April 2011 futures.  The focus of my article is provide some perspectives on why one should consider going long or short gold exposure, a quick look at some of the more common valuation methodologies, and finally some options for the casual investor to obtain exposure. 

    I suspect that most people buy gold in the hopes of getting rich based on the belief that tomorrow it will be worth even more.  The question here is what drives that belief and are there better ways to profit from those beliefs if they turn out to be correct.  To me, this perspective is simply speculating on the price of gold, which is not such a great investment theory.  However, the problem with gold is that it does not produce any cash flows that can be valued nor is commonly used in any practical purpose so can one really invest in gold?  Gold is valuable largely because we believe it is valuable and everyone seems to agree. 

    The next reason the gold is useful as an investment is as a hedge.  Gold can act as a hedge against both U.S. dollar currency risk and inflation.  If the value of the U.S. dollar falls, the value of gold and commodities in general will rise.  Oil is also subject to this phenomenon.  People often decry the notion of fiat currency as being false or lacking any intrinsic value.  Some people think we should return to the gold standard.  However, on some levels, gold itself lacks intrinsic value too.  While it is true that the government can print more money while gold is limited to what is discovered, is there really a big difference?  If  I hold U.S. dollars I carry the belief that the U.S. government is not going print 10x the amount of money and dilute the value of my dollar.  If I hold gold, I place the belief that everyone else will continue to value it the same as well.  Perhaps people are more comfortable trusting everyone else than the U.S. government.

    Another potential reason to use gold as an investment is to provide diversification to a portfolio.  Gold has essentially no correlation to the S&P 500.  I've looked at this several times in comparing the SPDR Gold Share ETF (NYSEARCA:GLD) against the SPDR S&P 500 Trust ETF (NYSEARCA:SPY).  The monthly correlation of price returns over the past 7 years was 6%.  When people decide that the market has become too risky (often when it is declining), they seek less risky investments - cash, gold, and U.S. securities.  However, a correlation near 0% does not mean that the security rises when the other securities fall, that would be a -100% correlation and would act as a hedge.  Hence, to get a 0% correlation a security has no relationship.  If SPY is showing negative returns it is probably equally likely that GLD goes up as it could go down. 

    A final reason, someone might own gold is simply desire.  I don't see this as an investment reason. Throughout history gold has been ascribed with positive qualities and seen as desirable, largely because of its rarity, but also for its luster and appearance. 

    Because gold lacks any cash flows to discount nor is critical in large quantities to industry, investors often compare it to other securities and see if the price is moving out of line.  (It is used in production of electronics in very small quantities due to its electrical and other properties.)  Based on some reading, the following assets seem pretty common for comparison:

    Silver - another precious metal, silver has similar attributes to gold, but also more practical applications.  To that extent silver exhibits a higher correlation to the stock market (around 30-40%).  The casual investor can obtain exposure through iShares Silver Trust (NYSEARCA:SLV)

    So over the last 30 years, gold has traded from 40x to 100x the price of silver and is currently around 44.5x as of February.  This would suggest a potential pairs trade of going short silver and long gold.  However, even based on this history, gold has traded at a

    - I've seen a few articles showing the ratio between the SPY and gold.  

    Back in the early 80s, gold was near $500 a troy ounce and the S&P 500 was around 130 giving a pretty high ratio.  Since then the S&P 500 outpaced gold until the ratio hit a 30 year low of  0.18 in August 2000 - right around the bursting of the tech bubble.  You can also see small spikes up during points of high fear in the stock market.  So the current ratio is right around 1.  While perhaps a longer history of this ratio would provide some other insights, I don't think there is a theoretical justification for making some sort of pairs trade in any direction.

    Ways to get long or short gold
    So depending on your beliefs there at least many different ways to gain long or short exposure to gold, ranging from the more exotic derivative securities to GLD or simply purchasing the physical commodity (probably a bad strategy)

    ETF commodity options - There are several long and short options, including ones with leverage as listed below:

    Gold ETF options
    TickerNameAssets ($ Billions)DirectionLeverage
    GLDSPDR Gold Shares51.89Long1x
    IAUiShares Gold Trust 5.33Long1x
    SGOLETFS Physical Swiss Gold Shares 1.24Long1x
    DGLPowerShares DB Gold 0.28Long1x
    DGZPowerShares DB Gold Short ETN 0.10Short1x
    DZZPowerShares DB Gold Double Short ETN 0.10Short2x
    DGPPowerShares DB Gold Double Long ETN 0.49Long2x
    Source: Yahoo!Finance

    Gold Mining Stocks
    Another option would be to go long or short different gold miners.  Different mining companies will have different leverage to gold prices based upon their cost structures. I reviewed this impact in an earlier article.  However, mining companies often mine other metals which dilutes there overall exposure to gold.  The following companies could be gold options:

    Gold Mining Stocks
    TickersNameMarket Cap ($ millions)Price/Book
    ABXBarrick Gold Corporation                    51,496                       2.5
    GGGoldcorp Incorporated                    39,489                       1.8
    NEMNewmont Mining Corporation (Holding Company)                    26,333                       1.7
    AUAngloGold Ashanti Ltd.                    18,932                       4.6
    IVNIvanhoe Mines Ltd                    17,891                       8.0
    GFIGold Fields Ltd.                    12,470                       1.8
    AEMAgnico-Eagle Mines Limited                    10,977                       3.0
    KGCKinross Gold Corporation                    11,275                       0.8
    EGOEldorado Gold Corp                      8,906                       3.0
    AUYYamana Gold, Inc.                      9,156                       1.3
    IAGIamgold Corporation                      8,298                       2.9
    GOLDRandgold Resources Limited                      6,743                       3.7
    HMYHarmony Gold Mining Co. Ltd.                      6,559                       1.5
    NGNovagold Resources Inc New                      2,998                       4.9
    RGLDRoyal Gold, Inc.                      2,801                       1.9
    Data is provided by services.

    Alternatively, there are gold mining stock ETFs such as Market Vectors Gold Mining ETF (NYSEARCA:GDX)  and Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ). Some smaller junior companies include:

    TickersNameMarket Cap ($ millions)Price/Book
    ANVAllied Nevada Gold Corp                      3,102                       5.9
    HLHecla Mining Company                      2,527                       2.4
    CDECoeur d'Alene Mines Corporation                      3,130                       1.5
    Data is provided by services.

    The goal here was to provide some perspectives on rationale for investing in gold and different options to pursue it.  The most direct way for bulls would be to simply go long DGP and for bears to go long DZZ.  However, there is potential to obtain even greater leverage through very margin gold miners.  These would most likely be junior miners. 

    The following returns show the recent 1 year performance of select long investments:

    Ticker1 Year Return
    GDX 37.2%
    Source: Yahoo!Finance

    Disclosure: I am long SPY.

    Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.
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