Reinhard

Gold Bulls Should Stay Away from Gold Stocks

There are several factors why sometimes mining shares can be good investments, and sometimes gold itself.
- Falling oil prices have been mentioned above, and more generically, any deflationary wave can be good for mining stocks. Imagine the current period lasts for two years, where gold drops 10% and other prices drop in the aggregate by 20%. Here, mines actually make you money, while gold not. And the observed leverage can change in a hurry.
- Tax considerations, availbility in IRAs, safety of your investment are other considerations. Especially if the U.S. government goes hostile. Under certain circumstances, I rather trust mining executives.
- Mining companies seem risky, but therefore one should receive a "required rate of return" for lending mining companies money for their operations. If not, nobody would lend them eventually. So, if mines make a profit in the long-run, the investor should be able to earn a real return in the long run. Gold itself just preserves its real value in the long-run. In adverse times for gold, e.g. when it went from $850 to $250, large mining companies might not have lost 70% (including dividends), but could hold their ground.

So best is to own mining shares as well as gold, and rebalance occasionally between them.

Value of Gold Over the Ages

What's mostly wrong with this graph, IMHO, is the "adjusted for inflation" part, since they most likely use a CPI (consumer price index). First, the CPI is always understated by governments having an agenda (so they can pay out smaller entitlement payments). Second, even if it was right, it is not the correct measure of adjusting for the price of gold, since gold is a hard asset, while consumer products get cheaper due to efficiency of production.
The right measure is the money-supply which measures the rate of creation of money and credit. This is the rate at which money loses its value compared to something that isn't much created or destroyed (gold). This would tilt the above graph downwards and make gold cheaper than it looks. Why should gold have a value at all? It has a utility as medium of exchange and storage of wealth, and is probably worth a certain proportion of our total wealth, depending on how much we trust other investments and paper money. If paper money is created at a rate of 7%, the interest rates should be at least 7%. At 10%, one can still stay ahead of the devaluation. If interest rates are only 5%, paper money loses its relevance as an investment, and people will wake up and rather hold gold. This is why gold fluctuates and doesn't go exactly inversely to the money-supply.