Thinking Outside the Golden Box
Manny is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I have to admit, my computer is going crazy with gold bugs. If you’re anything like me you are also wondering what to make of all the current fuss about gold. Buy or sell? Strike now, or wait? It turns out that just asking these simple questions is an invitation to go a little nuts.
Losing Your Hat and Your Lunch
Even if you don’t wear any gold, you probably still have a strong opinion about it. After all, just about everybody does. But opinions are cheap and easy to come by. Most of them are contradictory.
It is true that gold has had a great run over the past three months. But where is it headed next? The chart above proves that the value of gold is anything but stable and predictable. And, let’s not forget that gold briefly hit a high above $1900 an ounce in 2011. So if you are a buy-and hold-investor, and you bought at the peak of excitement about gold, you may still be in the red.
As one wit said, “It’s like a roller coaster ride. You can lose your hat and your lunch on the ride, and then wind up right back where you started." Gold is NOT a stable investment.
Drinking From a Fire Hose
So where is gold going next? I just about got swamped by an outpouring of mixed opinions when I began looking for information about the future of gold. As the old saying goes, it is like trying to take a sip of water from a fire hose.
Amid all of the conflicting opinion, some sources even suggested I don’t buy gold at all. They argue that another precious metal, silver, has had a much better run-up recently. Indeed it has, but does that make silver a buy now?
Silver has risen 25% over the past three months, easily trumping gold’s recent gains. But consider this. Silver is still 40% below its peak two years ago.
Both gold and silver bugs have lost money by buying in a period of excitement. I don’t like chasing performance. And, as the gold and silver bugs of last year discovered, no one can predict the future. I say chasing a rising star is a sure way to fall into a ditch.
What About the European Crisis?
Gold bugs are wide-eyed creatures, ready to believe anything that backs up their arguments.
With Europe’s troubled central banks scrambling for stability, Reuters reports that central banks will purchase a total of 493 metric tons of gold this year, an increase of 7.9%. You would think that would push prices up, wouldn’t you? But consider this. Every time the eurozone hits a crisis, the value of gold goes down.
How is that possible? Shouldn’t a crisis create a demand for the safety of gold? Here’s the reason. Gold is denominated in dollars. If Europe has another crisis and the euro falls in value, the dollar will naturally rise.
A more valuable US dollar means less valuable gold.
And what about quantitative easing? You know that plan announced last month by the US to print money in hopes of boosting the economy. Won’t that drive gold prices up? Perhaps, but it is also possible that all of the past economic news is already baked into the price of gold. The future remains uncertain.
The “Usual” Alternative
Investing in gold mining is usually the best way to go according to some gold enthusiasts.
And, many gold bugs say the most cautious way to play the gold miners is with the Market Vectors Gold Miners’ ETF (NYSEMKT: GDX). As you’ll see below, it has had a nice run-up over the past few months.
Yes, it was a great run, but that seems to be topping out now after a volatile year. And keep in mind that the GDX is dominated by just a few very large mining companies.
Amazingly, the index is still below its high for this year. It is even further below its high of last year which peaked above $65.I do like some of the smaller individual mining companies. But there is no reliable way to tell which way the miners’ index is going in the future.
A Safer Alternative
Gold mining is extremely risky and an equally risky investment. That’s partly because gold is so rare, and the world’s large remaining deposits have become extremely difficult to extract. Many mines are located in politically troubled areas. They require huge investments of capital with sometimes uncertain results.
For an example, consider the risk with the giant Oyu-Tolgoi gold and copper mine. It is a $7.3 billion investment located in lower Mongolia, controlled by Chinese and Mongolian authorities (who all are jockeying for a bigger piece of the action).
After looking at all the alternatives, I like the look of investing in companies that operate like a gold miner’s bank. Among the players are Franco Nevada (FNV), Royal Gold (RGLD) and Sandstorm Gold (NYSEMKT:SAND).
Sandstorm is soaring because it has found a way to de-risk gold-mining plays.
Companies like Sandstorm finance gold mining operations and then get their payback from a stream of royalties. By capturing about $500 an ounce from a mine’s royalty stream, these banks skim off the cream. Price fluctuations and political risk are much less important with this financing arrangement.
Of the three big players in this field, Sandstorm seems to have the best valuation and future upside. The company’s cash flow is expected to double this year and grow by another 43% in 2013.
Gold without market risk sounds good to me.
Keep in mind that the spot price of gold can fluctuate anytime if the World Gold Council or the International Monetary fund use their reserves to manipulate prices. Even India, the world’s largest gold consumer, can influence prices as demand in that country weakens.
I like the safety of the gold banks like Sandstorm. Their slice of the royalty stream is well below any conceivable future dip in gold prices. That’s a measure of safety in a field that almost everyone says they can predict but no one really can.
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