Foolish Investors Need to Own at Least Some Gold

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

As a consultant in the natural resources space, I look at many companies in sectors like coal, iron ore, potash, gold, silver, copper, etc. In this 2 part piece I share my view on gold. Before I begin, I am not an expert in gold and I don't have special insights into the direction of gold prices. The following is just my opinion based on years of covering mining companies.

There is so much written on the topic of gold that it's difficult to decide where to start. However, I can recommend a great place for readers to start, right here, the World Gold Council. Anyone serious about understanding the gold market should visit this site. Back to this article, every investor should have at least 5% of his or her portfolio in actual gold or gold stocks. Some experts might argue for a larger allocation to, "precious metals." To keep it simple, I will stick with gold, and henceforth when I say gold I mean gold and/or gold company stocks.

I know what readers may be thinking...that I'm about to launch into a series of arguments to demonstrate that gold prices are headed to $3,000 per ounce, and SOON! I don't blame you. A lot of the information about gold available on-line is tied to gold traders and gold stock speculators. The same people who carefully explain that gold is a long-term investment, then pull out the technical jargon and charts to persuade you to buy gold NOW. Forget about all the technical crap and ignore the used car salesmanship. 

The arguments for owning gold are straight forward, yet the vast majority of us hold no gold, zero, none. Gold is not merely a commodity like copper or coal. It's a globally respected store of wealth, a hedge against inflation and a safe haven when markets crash. Many of us have heard this pitch before. Notice I didn't say it protects against, "tail risk." Keeping it simple here.

I'm not here to tell you that gold prices are certain to go higher or that next year the gold price will be $XYZ per ounce. Over the next week, month or quarter, who knows? Longer-term I think one has to turn to global Supply and Demand to form an opinion. Hold on, didn't I say that I'm no expert in gold? Yes I did. However, I am an expert in the mining of commodities, (especially coal). So here it comes, the crux of my thesis on why everyone should own at least some gold. I only know one thing about gold, ongoing supply will be challenged....

In a recent annual report, Ernst & Young said, quote, "...resource nationalism was cited as the #1 global risk in the mining and metals sectors. The risks facing the sector have become more extreme and more complex due to the fast changing investment and operational environment. Resource nationalism was listed #8 in the report just 5 years ago. This risk continues to grow."

Last year, two-thirds of global gold production came from the countries listed below. Of the 1,859 metric tonnes of supply, 24% (South Africa, Peru, Ghana, Indonesia and Mexico) is from countries facing significant and increasing instances of resource nationalism. The bottom third of production comes from countries including Mali, Uzbekistan, Papua New Guinea, Mongolia, Venezuela and Zimbabwe. Taken together, I estimate that roughly 40% of gold production comes from increasingly challenged jurisdictions.  

<table> <tbody> <tr> <td> <p><strong>Top 10 Gold Producers</strong></p> </td> <td> </td> <td> </td> </tr> <tr> <td> <p><strong>(metric tonnes)</strong></p> </td> <td> <p><strong>2011</strong></p> </td> <td> </td> </tr> <tr> <td> <p>China</p> </td> <td> <p>380</p> </td> <td> <p>13.6%</p> </td> </tr> <tr> <td> <p>Australia</p> </td> <td> <p>272</p> </td> <td> <p>9.8%</p> </td> </tr> <tr> <td> <p>U.S.</p> </td> <td> <p>243</p> </td> <td> <p>8.7%</p> </td> </tr> <tr> <td> <p>South Africa</p> </td> <td> <p>221</p> </td> <td> <p>7.9%</p> </td> </tr> <tr> <td> <p>Russia</p> </td> <td> <p>205</p> </td> <td> <p>7.4%</p> </td> </tr> <tr> <td> <p>Peru</p> </td> <td> <p>156</p> </td> <td> <p>5.6%</p> </td> </tr> <tr> <td> <p>Ghana</p> </td> <td> <p>102</p> </td> <td> <p>3.7%</p> </td> </tr> <tr> <td> <p>Canada</p> </td> <td> <p>101</p> </td> <td> <p>3.6%</p> </td> </tr> <tr> <td> <p>Indonesia</p> </td> <td> <p>97</p> </td> <td> <p>3.5%</p> </td> </tr> <tr> <td> <p>Mexico</p> </td> <td> <p>82</p> </td> <td> <p>2.9%</p> </td> </tr> <tr> <td> </td> <td> </td> <td> </td> </tr> <tr> <td> <p>Top 10 Total (tonnes)</p> </td> <td> <p>1,859</p> </td> <td> </td> </tr> <tr> <td> <p>Global Total</p> </td> <td> <p>2,789</p> </td> <td> </td> </tr> <tr> <td> <p>Top 10 as % of Global</p> </td> <td> <p>66.7%</p> </td> <td> </td> </tr> <tr> <td> <p><em>Source: CRU Consulting</em></p> </td> <td> </td> <td> </td> </tr> </tbody> </table>

Therefore, without even trying to predict future demand, I feel pretty confident that supply will be challenged. If true, gold prices could increase even with flat demand. One simple observation on demand is that if per capita, "consumption," of gold holds constant, more supply would still be needed as the world's population grows. Add to that, the continued emergence of middle class populations around the globe. I for one believe that gold demand will not fall and of course could increase.  

With regard to gold companies, two majors that should be considered are Newmont, (NYSE: NEM), and Barrick Gold, (NYSE: ABX). Newmont is especially interesting because it has adopted a dividend policy whereby its quarterly dividend is directly linked to the underlying price of gold. If gold prices increase, the company's dividend will increase. If gold prices decline, so will Newmont's dividend. Barrick is the world's largest gold producer and has an amazing amount of gold reserves and resources yet to be exploited. Barrick's website states that the company has the lowest cost structure among gold major peers. 

A number of gold enthusiasts believe that junior gold companies are the way to go. I tend to agree. In my next article I will discuss a few emerging gold producers that may be in the sweet spot for significant out-performance in 2013. 


MockingJay2011 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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!

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