Why gold? It's the most obvious question, but just the first of four questions you should ask as an investor:
1. Why gold?... 2. Why gold stocks?... 3. Which stocks?... 4. Why now?
GSA supplies the answers:
1. Why Gold?
Blame the politicians for continually debasing the U.S. currency. It's not that gold is "up" so high‐it's that that the U.S. Dollar is "down" so low.
Always running for re-election, politicians try to get nine slices out of an eight-slice pizza. This means they promise voters more benefits than the economy can deliver. And attempting to make good on pledges, they pass annual government budgets with deficits, keep other spending off-budget, and confirm Federal Reserve Chairmen that see a little inflation as a beneficial lubricant to the economic gears.
Further, wanting re-election means that politicians become slaves to special interest groups and their campaign donations. This means rewarding donors with narrowly defined tax loopholes that cut government revenues, and earmark spending to benefit other special interests. Both put a balanced budget further out of reach.
Fiscal policy and monetary policy can both debase the currency. The Treasury issuing bills, notes, and bonds to finance deficits is the same as the Federal Reserve printing money. There is no real difference between a 90-day Treasury bill issued for $1,000 and $1,000 in currency printed by the Federal
Reserve; they both can be used to buy that ninth slice of pizza.
What can be done? Complaining about or to politicians is a waste of time. It's their nature to pander to voters and they will never change. The best approach for investors is to recognize the situation and use it to profit. Over time, most "hard assets" will protect investors from a currency's loss of purchasing power, simply because their supply is far more limited than the supply of printed T-bills or Dollars.
But while any hard asset will work in the long term, we favor gold because it is much more liquid than real estate, collectibles, rare art or other investment vehicles
2. Why gold stocks?
Once one has decided on gold, the next question is the actual investment.
Some might choose gold coins. The safest are those that sell based solely on their gold content, and not rarity or other qualities that might cause coins to sell well above their intrinsic gold value. The easiest to buy (or sell) at the lowest premium (or discount) to gold content are the one ounce coins: the American Gold Eagle, the Canadian Gold Maple Leaf, and the South African Krugerrand.
Other investors, to avoid dealer markup, shipping, possible sales tax, and coin storage and insurance costs, may choose to buy shares of one of several gold ETFs. Not only are the commissions low, but there are no storage charges and they are SIPC-protected, like all securities in a brokerage account.
But, the gold investment vehicles we favor are gold mining stocks, due to the leverage they offer to gold's price. This leverage comes from two sources:
- Current production becomes more profitable as gold price increases, thus justifying a higher stock price, and
- Reserves still in the ground become more profitable. With miners often having reserves of ten times the annual production rate, it's pretty easy to extrapolate the total profit increase from a rise in gold price.
The adjacent chart demonstrates the leverage gold stocks have versus gold price, and why in bull markets the stocks are a better investment.
3. Which gold stocks?
Investors must choose from two major groups: Explorers, of which probably 1,000 are publicly owned and Producers, of which only about 50 trade in North American stock markets.
To this latter group, we can add near-producers, miners that have taken a deposit through the bankable feasibility stage and an independent engineering firm's analysis has shown that: 1) drill holes are spaced close enough to have high confidence about the ore grades in-between the holes and thus justify the Proven and Probable Reserves (P+P) classification, and 2) that the capital investment required to put the site into production will yield a profit, or economic return. Just as an independent auditor's sign-off on a company's financial statement is critical for investors, so too is an independent engineering firm's sign-off on the deposit's economics, and it's required by the U.S. SEC for a miner to be able to call its ounces in the ground P+P Reserves.
GSA only follows producers and near-producers as they are the only miners with data confirmed by third parties and thus have solid numbers that can be analyzed.
The gold mining industry is unique. All the miners produce exactly the same final output, ounces of gold. Unlike Coke and Pepsi, they spend nothing trying to tell consumers that their gold is the best. The miners simply accept the current gold price when they sell. With all ounces the same, and selling for the same price, one might think the stock prices would reflect similar valuations for Miner A's ounces versus Miner B's ounces. But, in fact, the stock market is not efficient and the valuations can vary widely. This gives an opportunity for investors.
Below is a portion of a page from a past issue of GSA Top10: it shows the Market Cap/oz of reserves valuations for 12 of the 60 gold miners covered by GSA:
Since all gold ounces are the same, and sell for the same price, GSA wonders why the Market values the miners' ounces at very different prices. Why, for example, are Agnico-Eagles' just under 16 million ounces of P+P Reserves each valued ten times higher than those of Crystallex? With both having new mines in Mexico, why are Gammon's 5 million ounces valued at $100/oz above those of Minefinders?
Sometimes the different valuations are justified by lower production costs or the uncertain politics of the nation in which the ounces are located. But sometimes the disparities are not reasonable and the market is being inefficient, and not properly valuing the ounces. These undervalued situations create the opportunities GSA searches for, and are why a portfolio of its Top 10 Stocks has gained an average of over 35% per year since 2001.
4. Why now?
The short answer: The "Real Interest Rate."
New investors interested in gold always fear buying at the top. The negative comments by the know-nothing "talking heads" don't help (If they're such gold "experts", where were their "buys" at $300 per ounce?). GSA has proven we can make money in any gold market by focusing on those miners undervalued versus their peers, based on the Market Cap/oz metrics we use.
But the "newbies" often want the comfort of a single indicator to forecast gold's future before they climb on board. Our work says the "Real Interest Rate" is the best forecaster. This is the risk-free return on money, adjusted for inflation. We find it by subtracting the CPI from the three-month Treasury yield. When the result is positive, gold is flat. When the result is negative, gold price soars. This is because money loses purchasing power in a negative real-rate environment and investors seek the protection of "hard assets".
At the current +1.1% CPI and a typical 0.1% money market yield, $100 at the start of the year will have only $99 purchasing power at the end.
We see a negative real-rate condition for the next several years as the Fed will be unable to raise interest rates due to the high U.S. unemployment rate. And even when Fed begins raising rates, if it lags the CPI increases as it did in the 1970s, gold will still move higher.