FEATURE
Bully for Bullion!
A likely pullback in prices for the yellow metal will be the green light to pounce on gold plays such as Rangold and Goldcorp.
GOLD HAS GLITTERED AS AN INVESTMENT in the past 10 years, gaining in price and popularity as financial uncertainty has grown. The yellow metal has rallied 336% from its 1999 bear-market low, trouncing stocks' meager returns. Two weeks ago bullion made headlines by punching through the $1,000-an-ounce barrier for the second time ever, to the delight of gold bugs and other holders of physical gold and gold-related equities and funds.
Given its 41% advance since last fall, gold could correct in the near term, possibly by 10% to 20%. But it is likely to head higher in the longer term, especially if massive government spending leads to inflation. Consequently, investors should consider allocating 5% to 10% of their portfolios to gold, buying advantageously when prices dip.
Gold is a psychological investment. Unlike companies, it doesn't have earnings, so there are no historical price/ earnings ratios to analyze. Rather, it is considered a hedge against inflation, and a safe haven in times of turmoil. Ironically, the price of gold hasn't kept pace with inflation. Gold peaked in 1980 around $850 an ounce, the equivalent, adjusted for inflation, of $1,500 to $2,500 today, says John Bridges, a metals and mining analyst at JPMorgan.
The latest rally was sparked by a decline in the dollar, which has fallen 15% against the euro since its recent high last fall. The flight-to-quality trade has reversed amid signs the economy may be reviving, while inflation worries have increased as the U.S. budget deficit has climbed.
If that happens, the dollar could bounce and gold might return to levels around $750. To Nordberg, "the big risk is deflation, not inflation." About a third of his firm's assets were in gold-related investments until last spring, when he sold for a bit below current prices.
Yet Nordberg anticipates returning to the gold market after a correction because he expects the Federal Reserve will have to issue more money to buy U.S. Treasuries to fund the deficit. He also expects the government to put more money into the nation's banking system as banks continue to fail. His long-term forecast: inflation, a weak dollar and a glowing gold price.
Some investors like to judge gold by what it can buy. In days of old, it was thought an ounce of gold should equal the price of a new suit. At the peak of the last bull market in bullion, gold's price roughly equaled the value of the Dow Jones Industrial Average. Not anymore; today the Dow is more than nine times the price of an ounce of gold, says John Hathaway, manager of the $1 billion Tocqueville Gold Fund (ticker: TGLDX). To return the ratio to parity, stocks would have to collapse -- or gold, soar.
It wouldn't be surprising "to see gold double from here," says Hathaway, who called for gold to hit "four digits" in a 2005 Barron's interview, when it was below $500.
ONE STIMULANT TO GOLD PRICES in recent years was the creat
ion of a gold exchange-traded fund, the SPDR Gold Trust (GLD), in 2004. "ETFs have been taking supply out of the market and boosting demand by making it easier to buy gold," says James Bianco of Bianco Research.
Before the creation of the ETF, bullion investors bought gold bars or coins and paid for storage and insurance, expenses that ate into returns. When they buy shares in the ETF, an equivalent amount of gold is purchased on their behalf and stored at very low cost.
As a result, GLD and other ETFs are among the largest global buyers and holders of gold. In 2008, 8% of world gold demand came from ETFs, says the World Gold Council. Six years earlier, demand from ETFs barely existed.
To some extent, the creation of gold ETFs has transformed gold into a financial asset similar to stocks and bonds. The low interest rates that are helping to inflate financial assets also might be contributing to the rise in gold and gold stocks. Bianco thinks it will be time to sell when the Federal Reserve begins to raise interest rates and the bubbles he sees forming in all financial assets -- stocks, bonds and gold -- start to deflate.
Some financial buyers, such as hedge-fund manager John Paulson, have jumped into the gold market enthusiastically. Paulson has invested about a third of his $19.8 billion portfolio in gold, including nearly 16% in the SPDR Gold ETF, according to the most recent SEC filing. He also owns stakes in gold miners AngloGold Ashanti (AU), Kinross Gold (KGC), Gold Fields (GFI) and Market Vectors Gold Miners (GDX), a mining ETF.
In addition to more demand, gold prices have benefited from tighter supply. It has gotten tougher to find new deposits, and more expensive to mine existing ones. Money has poured into ETFs, but little has gone into building industry capacity.
BUYING BULLION OR THE ETF instead of mining stocks was a winning bet for most of last year, but things changed after the stock market bottomed in March. Gold-mining stocks have outshone bullion since, a trend that could continue if gold stays near $1,000 an ounce. That price isn't yet factored into gold-company profit estimates.
Bridges, the JPMorgan analyst, has an Overweight recommendation on Newmont Mining (NEM) and expects the company to earn $2.28 a share next year, based on Morgan's gold forecast of $950 an ounce. If gold stays around $1,000, Newmont could earn $2.86 in 2010, 25% more than his current estimate. Gold mines have high fixed costs; almost every dollar of sales above them falls straight to the bottom line.
Mining companies are a riskier investment than bullion, however. They could underproduce, or face escalating costs, as they did last year when energy prices rose. Political risk is also a factor in some countries where mines are located.
Fred Hickey, editor of the High-Tech Strategist newsletter and a member of the Barron's Roundtable, became a gold fan about a decade ago when he realized the technology bull market was ending and he began looking for a new bull market. Hickey likes gold companies with no exposure to South Africa or other countries that might try to nationalize assets. He also likes miners with growing production and earnings, including Goldcorp (GG) and Yamana Gold (AUY).
These days there are many ways to bet on a higher gold price, and many savvy buyers making that long-term bet.
Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved
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