The Time for Gold Is Now

James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Gold, while certainly a hallmark of John Q. Public’s portfolio, has long been characterized as a serious investment only for the doomsayers and misers among us. Considering that an investment in gold does not produce income in the same way that equity and debt does, this is entirely rational. However, it is time for gold to play more of a role in the private investor’s portfolio than simply as an inflation hedge. Put differently, inflation hedging needs to become more of a priority in the private investor’s portfolio. As an increasing number of central banks engage in quantitative easing, debt monetization, and competitive devaluation of their currency, investors in gold now will reap the benefits when everyone else wants in later.

On Sept. 13, 2012, the Federal Reserve announced QE3, the third installment of quantitative easing whereby the Fed purchases $40 billion in mortgage-backed securities each month for an indefinite period of time. All of this is in addition to Operation Twist, an ongoing Fed OMO that seeks to invert the traditional yield curve of bonds by selling short-term government debt and buying long-term. To evaluate whether or not all this liquidity will impact the money supply, it is important to determine where it is going. In these cases, QE3 and Operation Twist funds go towards banks, the primary holders of mortgage-backed securities (MBS) and treasury securities. This implies that the money base will be vastly augmented, but as to whether the money supply will be affected depends on when banks make loans – a question of when, not if. At that point in time, the ensuing inflation would erode the value of the dollar, making gold an extremely attractive investment.

Elsewhere in the world, currencies are facing the threat of devaluation through central bank activity as well. The President of the European Central Bank (ECB) Mario Draghi recently stood by the option of initiating a bond-buying program known to some as a “nuclear deterrent.” If employed, the European Monetary Union’s (EMU) money supply would eventually expand and expose the Euro to inflation as well. Although the ECB is currently unable to directly buy sovereign debt from governments, it can still provide liquidity to EMU banks. Of course, as these banks purchase sovereign debt in the same way that the Central Bank would, the outcome is effectively the same – an increase in the money supply and inflation. According to World Bank, in 2011 the US and EU comprised roughly 47% of the world economy by GDP. Thus, the central banks associated with roughly half the world’s economy are printing and injecting money into the financial system. If that isn’t a compelling case for gold, you might as well stop reading now.

Furthermore, central banks have an even more obvious motivation to devalue their currencies: when domestic currency is worth less than before, demand for domestic goods and services will increase from abroad and the domestic balance of trade will benefit from in an increased amount of exports. While harmless sounding, sometimes central banks will fight to devalue their currency more than the rest. This sort of competitive devaluation between nations allegedly worsened the Great Depression according to studies done on the subject. Gold, valued for its scarcity, will be an especially appealing investment if any of these policies are put in motion.

So, how can you invest? You can buy gold bullion and coin from jewelers or general retailers. Be sure to do your research to avoid coughing up extra cash via premiums. This form of getting in on the gold market may not be as liquid as others; physical gold is usually harder to sell than a security trading on a market.

Another popular way to get into the gold market is to purchase a gold exchange-trade fund (ETF). Top-rated ETFs include ETFS Physical Palladium Shares (NYSEMKT: PALL), SPDR Gold Trust (NYSEMKT: GLD), and ProShares Ultra Gold (NYSEMKT: UGL). All three of these ETFs track the spot price of the rare metal concerned. ETFS Physical Palladium is based on an index that tracks the price of palladium, an exceptionally rare white metal whose price fluctuates alongside gold. Of course, the price/earnings ratio that is typically used when evaluating the price-level of a security does not apply to these offerings, considering that they will yield no “earnings.” ETF Investors seek to make their money through capital gains only. You can also purchase gold exchange-traded notes (ETN). ETNs are similar to ETFs in that the return is wholly contingent upon the performance of an agreed upon index. 

Another option are the stocks of gold-mining companies. Notable gold-mining firms such as Barrick Gold (NYSE: ABX) or Newmont Mining (NYSE: NEM) are some of “the world’s biggest gold producers” according to the WSJ. Accordingly, these companies produce earnings and can be evaluated in ways that ETFs merely tracking the price of gold cannot. Barrick Gold trades at 10 times earnings, while Newmont Mining trades at 107 times earnings. Barrick Gold also reports a gross profit margin of 59%, while Newmont Mining comes in at slightly lower 55.2%. Finally, Barrick Gold's ROIC is 9%, while Newmont Mining scores a much less impressive 3%. As to which is the better stock for you depends on your portfolio, characteristics, and investment management strategy.

The time is now! At the very least, get some gold into your portfolio to guard against the expansionary monetary practices of central banks around the world. At risk of sounding like one of those broken-record gold salesmen on TV, it could be one of the best investments you’ll ever make. 


Fool blogger James Kerin does not own shares in any of the companies mentioned in this entry. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure