I bought my first gold stock in 1982 and I have had a love hate relationship with it for many years. I will try to define what gold is and why it has or doesn't have value. I believe the metal frustrates investors because they don't understand what it is. We are confident in the markets with a new president and gold and gold miners have really suffered.
What Is Gold?
Gold is an original precious metal prized by kings and pirates for centuries. Archaeologists have discovered a treasure trove of gold coins and artifacts in buried cities both on land and in water. I choose to call it ancient money so from that perspective you can see why it still has value as an antique. In many respects the gold standard was a good idea which doesn't work well in today's economy. The reason is simple, there's a limited supply of gold and to divide it into more units is very difficult. Gold stopped being currency for the USA in 1971. From this link.
The government held the $35 per ounce price until August 15, 1971, when President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value, thus completely abandoning the gold standard.
What Helps The Price Of Gold?
Gold is difficult to find and very hard to process. Due to its rarity and processing difficulty it continues to remain rare. Once out of the ground and processed, it is easy to work with which makes it ideal for jewelry and a few electronics but mostly used to store value. Because it's so rare and expensive to process the global supply of gold doesn't change very much.
An estimated total of 174,100 tonnes of gold have been mined in human history, according to GFMS as of 2012. World production for 2011 was at 2,700 tonnes.
Global mining, manufacture and storage works out to 1.6% growth of total supply per year. This explains the base value inflates 1.6% per year vs paper currency inflation of about 6%. However, that currency is also based on the economic value of the growth of the country so 3% growth and 2% inflation explains a lot. This is where understanding what gold is and isn't may help you.
Gold Is An Inflation Hedge
You can see by my math that gold supply also inflates as does currency. Think of two people walking side by side at the same speed (NYSE:RATE) and gold and money have the same value. When one person walks faster, it moves ahead or behind in speed (rate of supply growth). It's these changing rates of supply and demand that change the value in gold suddenly.
The US election has changed perceptions of the value of the USD because the theory is that lower taxes will speed up the economy (it will) and that is bad for gold. The effect of stimulus is faster and then when removed slower.
Gold Is Not Flexible
Because currencies can be made faster and slower at will or necessity, inflation (inflating the money supply) acts as a throttle and gold acts as a brake. Trump got elected on stimulus promise and that means money will jump ahead. Gold investors just have to wait for the brakes to either temper enthusiasm or reduction of stimulus to see where we end up.
So when money is growing too fast gold puts on the brakes.
Gold Is Heavy
The reason that gold is so heavy and not used for money any more is that it became (still is) an anchor. Anchors are heavy for a reason - stopping on choppy seas, slowing down, hard to move, etc. This is what gold is and why it needs to be lighter in your portfolio because at times it's too heavy to carry and your whole portfolio will suffer.
Like an anchor it will slow the current direction of your portfolio and if it's going the wrong way (your portfolio that is) it will slow that down too.
However, as an investment, it's hard to make money carrying around a bigger anchor than you need.
Gold As Insurance
So like an anchor it protects you from going too fast either direction (adding anchors on the way down doesn't help either). But it can also protect you from catastrophe (or cause one) in the event that high inflation returns. Investing in gold requires super human patience and luck because you are betting on future of failure to succeed. I can't really recommend it as insurance because life insurance is probably cheaper and less of a drag on your lifestyle. You need to understand why you need it before setting your portfolio allocation to precious metals.
Miners Or Metals
Making anchors is very different from carrying anchors. Miners are a leverage to what you expect gold to do. As an investment they are rarely correlated to the market and rarely produce wealth holding but you can make a little bit while waiting for gold to work. It's very difficult to find profitable miners, but when you find one it's often a profitable company in hard times.
As investors we have two choices. Buying the metal or buying the producers. On the producer side there are two types as well - miners and streamers. Miners mine metals, streamers finance miners via metal streams. Since I own both I will discuss those choices.
I've written about First Majestic, a silver miner based in Mexico. The reason that I chose them was liquidity, low cost production and they act like the metal (link above).
But with the further decline in gold and silver, I am switching horses mid-stream to reduce mining risk yet maintain PM exposure. I am adding Silver Wheaton (SLW) to my producer list and will eventually sell AG.
I also own a premier gold miner Agnico Eagle (NYSE:AEM) a larger miner based in safer jurisdictions.
I recommend a streamer first if you are new to PM.
Outlook For Precious Metals
I cannot predict the future price of PMs. Robert Balan right here on Seeking Alpha provides investors a tool called VAR Models (Vector Autoreggressions). You can see his latest blog here.
Click here for a live link.
My read on PM is that we are making a significant bottom but not necessarily the final bottom. Here's what I see in my own technicals. I find that I have to design my technicals based on what I see in the models. It makes it easier for me to understand the models.
Long Term View With Monthly Increments
You can see the long term trend is up. When I zoom into today, you can see the 4 version lines that I was and still am expecting. Looks like we are getting closer to the end of declines.
But I've been wrong before, so I would like to explain how a turn works. Take a step back from the monthly with my turn version.
I had to figure out a feature that I have never used, but seems to explain to me what is currently happening. I had to first imagine what was happening and then plot it using Fibonacci circles. You can see the circular lines above. Here's a look when you stand back.
You can see the circle placed on the last turn and where I think we are today is still somewhere in the turn. If this turn is like the last one we should know in a month or two.
Gold is a viable investment if you understand what it is and where we are. My own technicals have a low of $900 at some point in the future. While I personally think that can't happen, it's technically possible. I have never seen this behavior so it's a lot easier to see if it's happened before. I need you to understand that predicting the future is impossible and I am helping myself to clarify my thinking by writing my thoughts and sharing them with you. I would like to thank Robert Balan for allowing me to share his work with my own interpretations. I would also like to thank Ziad Jasani of the Independent Investor Institute for helping me with my technicals training.
Disclosure: I am/we are long SLW, AEM, AG.
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.