Disciplined Analysis of GOLD
“Purchase Timing For Profits”
Ned W. Schmidt, CFA, CEBS
WEALTH: THAT IS THE GOAL!
An investor must strive to keep the end goal in mind. Failing to focus on the purpose for expending efforts will in the end mean only
disappointment. For that reason we must insure that the goal is
appropriately formulated. That advice is true for policy makers as well
as investors. The reason that the Greenspan era has thus far been such
a dismal failure is that a proper goal was neither formulated nor adopted.
Indeed, looking back at the Greenspan era one would have trouble
ascertaining what the Federal Reserve's decision makers were trying to
achieve.
That the Greenspan Era will be recorded as economic failure is not
simply this author's opinion but the judgement of the markets. If we turn
to the graphs along the right-hand side of this page, we can observe the
results of investing either in Gold or U.S. equities. Over the past five
years or so an investor would have fared far better by owning
simple, but elegant, Gold coins rather than investing in the
productive enterprises of the U.S.
Most investors seemed to have thus far missed out on the wealth train's
shift from the equity track to the Gold track. The reason so many have
not yet boarded the right train, the Golden Train, is that goal has been
forgotten. Wealth is the goal for which all investment activities are
undertaken. The reason we invest is to accumulate and enhance wealth,
not to own stocks.
Owning stocks is not the goal. Owning mutual funds is not the goal. The goal
is the end point and that is the value of whatever it is you own. Your goal is
not to buy stocks or mutual funds, but to accumulate wealth.
Many have not yet shaken off the "stock/mutual fund" mentality which
hampers their investment results. Financial advisors and planners are still
plugging stocks and mutual funds. Some are still paying an advisor to help
them lose money in mutual funds. If wealth is your goal, then you must shake
off the stock delusion. The first question in investing your wealth is not what
stock to buy or which mutual fund had "twenty eight stars" last month.
CSCO, MSFT, AOL, etc. are part of history not the future. Once you
achieve enlightenment here, you will be able to move on to
understanding and owning Gold.
GOLD STOCKS ARE STOCKS:
Since we are on this tirade about stocks the subject of
Gold stocks might as well be addressed. Now, we are
talking about Gold stocks in general. Yes, we know that
some have that one, secret, small Gold mining stock that
has discovered a vast mineral deposit within a thirty
minute bus ride from Vancouver which will have total
production cost of about fifty cents per ounce. We really
are addressing all the other stocks, not these secret miracle
stocks.
The graph to the right is of the ratio of our Gold Stock
Proxy to the price of Gold. This proxy gives an indication
of the tendency or trend for the market value of Gold
stocks. As such, it approximates the movement of the total
market value of Gold stocks. The analysis has been
indexed to a base of March 2001, and the reason that date
is used is that it is about one year after the peak in the U.S.
stock market.
When this ratio is rising, Gold stocks are doing better than
Gold. When the ratio is falling, Gold is doing better. In
that graph a thin line has been added for the average of
this ratio. The two lines of boxes mark plus or minus two
standard deviations from the average. Statistically the
ratio should not be outside of those two lines very often.
First, the ratio clearly shows that Gold Stocks did better than
Gold. That conclusion is indicated by the ratio hitting a peak of
about 2 in May of this year. Since that time Gold stocks have
faltered. Gold has been preferable to owning Gold stocks for the
past eight months.
That the ratio moved up through that upper Range Band would
have been a good indiction that Gold Stocks were overvalued
relative to Gold. Using a term such as "Sell Signal" does not fit
with our overall philosophy, but that is what it was. A move above
the Range Bands suggests that we "sell" Gold stocks and "buy"
Gold.
The reverse would be the situation if the ratio were to fall below
the lower band. In that case we would "buy" Gold stocks and
"sell" Gold. And life would be far simpler if we knew that the
ratio was indeed now headed to below that lower Range Band.
What needs to be remembered is that Gold stocks can become
overvalued relative to Gold. Their performance can be a
disappointment even in a bull market for Gold. Gold stocks are,
after all, stocks not Gold. And we might add, if Gold is in a Super
Cycle on the way to $1,258 why not just get on for the ride and
avoid the risk of picking the wrong stock?
Some professional investors have sensed the over valuation and
are taking action to increase exposure to Gold and reduce
exposure to Gold stocks. For example, First Eagle SoGen Gold
Fund was the number one fund for the year ending September
according to the 7 October 2002 issue of The Wall Street Journal.
This fund's manager, while still a bull on Gold, is moving to less
volatile instruments to maintain Gold exposure. The Van Eck
International Investor Gold Fund is also moving to more direct
Gold exposure rather than buying only Gold stocks.(WSJ, 8 Oct
2002)
What we believe is that investors should do a serious inventory of
their skills and life styles. Do you have a lot of hours available to
do the research on Gold stocks? How do you deal emotionally
when one of your stocks crashes in the dirt? Are your stock
picking skills really as good as you would like them to be? If you
have any doubts when thinking about these questions then Gold,
coin or bullion, is the better route to go.
We will be bringing this chart back for those interested in it. And
before we move on, one last comment on Gold stocks. Someone
wrote us that he believed that Gold stocks were like "long-term
call options" on Gold. The response is simple. No way, no how
and never!
BUY SIGNALS:
For those that have requested email delivery of Buy signals we did
send one out last week. If you want to receive these e-mails,
which are not very frequent, let us know.
These signals are shown in the graph at the right.
The forces creating this signal are worth noting. YAHOO
announced earnings better than the guesses by the "yahoos" which
work as analysts. GE and FNM also came in with earnings that
were good relative to expectations. IBM did the same.
Most equity portfolios are experiencing horrible performance.
Hedge funds, which were to be the savior of investors, have also
had less than desired results. Any chance of a rally must be
pursued. Given that and a somewhat oversold condition, equity
markets rallied strongly. Funds were forced to move aggressively
into equities causing selling pressure on precious metals. That
selling set up an over sold condition in the Gold market. These
opportunities should be used by long-term investors to add to coin
and bullion positions.
VALUATION:
The table covering valuation appears at the top of the next page.
Both Gold and Silver continue to be undervalued, and positions
in both can be increased.
To the right is a graph of the five-year history of average monthly
Gold price, a five-year moving average and the fair value estimate
for Gold. As is readily apparent Gold is selling at a substantial
discount from fair value. This discount is a major part of the
fundamental case for Gold. From both a technical and portfolio
standpoint Gold is attractive.
Gold's current price is above the five-year moving average.
Investors that have purchased Gold in the past five years, on
average, have profits. This situation is in direct contrast to the
situation in equities where investors have losses. W hich is likely
to attract money? Yes, money is likely to be attracted to Gold,
which is making investors money, and away from equities, which
are losing investors money.
What makes the valuation issue so compelling is that both Gold
and Silver are in short supply relative to consumption/demand.
The key to the price of both metals is the investment demand,
which we believe will expand. Investors are simply running out
of places to put their money.
Some investors have sought refuge in the Gold stocks. However,
as we talked above that move has become less rewarding. Part of
the reason for that development is the lack of capitalization in the
Gold stocks. Quite simply, not enough Gold stocks exist to
consume the investment flow without pushing the valuation to
an unacceptable level. Gold itself, and Silver, must eventually
receive the bulk of investment flows.
Immediately below that valuation table and to the right is the
graph on Silver valuation we introduced last month. This graph
portrays the current valuation of Silver relative to Gold in a
statistical manner. The current valuation of Silver relative to Gold
speaking, Silver is a bargain. But, as all of us recognize Silver
needs its fuse lit. That match is still probably Gold breaking above
$330. If that is the case, then Silver investors will have to simply
remain patient.
THE VALUATION DISCREPANCY:
The valuation discrepancy might not be as important if stability
was a goal of economic policy in the U.S. What that means is that
Gold could conceivably fall well below fair value in periods of
exceptional economic stability. During those times marked by
serious economic instability, Gold should sell well above fair
value.
For the wide valuation discrepancy currently existing to be correct
we would have to be able to describe the current environment as
one of exceptional stability. That description would hardly be
reasonably applied to today's world. The greatest equity bear
market since the 1930's, massive corporate bankruptcies and all
else going on would hardly be called stability.
The Federal Reserve long ago abandoned economic stability as a
consideration for setting policy. Facts simply speak for themselves. A grand
speculative stock market bubble that burst. A building bubble in the housing
and mortgage markets that will too burst. A speculative binge in the U.S.
bond market that will ultimately explode, creating massive losses for
investors, pension funds, insurance companies, mutual funds and banks.
PIMCO's bond portfolio has now become the epicenter of investment
speculation as it balloons into the largest pool of investment assets, replacing
Janus and the others. This massive burst of speculation in bonds has been
driven by the Fed's policy of pushing interest rates to the lowest level in
decades. Investors are not buying bonds because they want to earn the paltry
rate of interest being offered. This movement is in response to massive losses
in stocks and a hope for capital gains. Money again is chasing a bubble, and
the Federal Reserve is the creator of that bubble.
Investors have yet to fully realize that the Federal Reserve is creating
instability rather than a stable environment. When reality becomes more
apparent after the bubble in bonds and mortgages bursts, investors will have
little choice but to move into Gold. All else will have failed by then.
Investors around the world are starting to recognize the difference between
short-term oriented monetary policy like that created by the Federal Reserve
and long-term monetary policy that values stability. The graph to the right is
of the Euro's value in dollars over the past three years. The European Central
Bank has a mandate to preserve the value of the currency. As the Euro is near
a three-year high, we must conclude that the investors are voting for the Euro
and against the U.S. dollar.
Currency values are maintained by policies aimed at creating stability. The
Federal Reserve is not pursuing such a policy. The Euro will continue to
benefit as will Gold.
GOLD STOCKS:
We have already stated the case for investors moving into Gold
rather than Gold stocks. Gold stocks may again become attractive
relative to Gold, and for that reason we present the table below.
The month was again not a good one for Gold stocks, though
Gold dropped only a few percentage points. The stocks have
simply run ahead of the fundamentals. Investors in Gold stocks
will need to be more discriminating in the management of
portfolios. Blindly buying is a habit from yesterday and not
appropriate for today.
The graph at the bottom left compares the valuation of the four
Gold stocks. ABX has been the most over valued, but is losing
relative valuation. The hedging activities of the company are no
longer seen as the wonder they once were.
NEM has become the favorite, once the cheapest of the four
stocks. The relative valuation has increased to the point where the
stock is now approaching the over valuation level of ABX. Too
much popularity exists at the present time.
The other two stocks, HGMCY and PDG, appear on the basis of
valuation to be the preferred alternatives. HGMCY has probably
been hurt by the discussions on empowerment in South Africa.
PDG has not enjoyed the acquisition experience as investors
shifted their focus.
At the bottom right is a graph of PDG. Included in that chart are
two price bands for an aid in buying. We continue to get an
occasional question on these bands so let us review them again.
Two price bands are calculated for each stock and are plotted in
the graph of the stock when included. The lower price band
corresponds to the line in the table titled, AGGRESSIVE BUY
BELOW. For example, PDG has traded down from about $13.50
to about $8.5. The lower price band is currently about $9.3. PDG
can be aggressively bought below that price. The upper price band
corresponds to the line in the table t itled, OK TO BUY BELOW.
The stock can be bought below that price but is not that exciting.
Value oriented investors would limit their buying to those stocks
below the lower price band, or the price that is listed in the table
as AGGRESSIVE BUY BELOW.
Too many investors have not yet broken the bad habits developed
during the technology stock bubble. During that period one just
bought a name and waited for someone dumber to come along and
buy it. Markets of today are far more discriminating. Investors
will need to pay far more attention to price. Limit your buying to
stocks below the price, AGGRESSIVE BUY BELOW.
What if the stock does not trade below that price? Easy, do not
buy it. Buying a stock at a good price is far more important than
just buying a stock. For example, someone complained that ABX
had not traded below the AGGRESSIVE BUY BELOW price.
And what had the stock done? ABX's price had declined. Despite
this investor's enthusiasm for Gold his stock selection ignored the
prices of the stock.
If one is not willing to be disciplined when buying Gold stocks
then disappointment will be the most likely result. Review your
own decisions. Were you more right on Gold or the stocks? If the
answer is that you were more right on Gold than stocks then the
appropriate future action is obvious. Buy Gold coins/ bullions and
ignore the stocks. Remember, the goal is to increase wealth. The
goal of this whole process is not simply to buy stocks. Stock
buying is not the goal. Wealth building is the goal.
INFLATION AND BOND YIELDS:
The reason for these last comments is a moronic discussion we
heard this morning on a popular cable investment show.
Essentially the comments focused on the outlook for inflation.
One participant asked if inflation is zero what was wrong with
buying bonds.
Another participant tried to explain that yields on 10 or 30 year
bonds are priced on the long-term prospects for inflation. The
inflation experience of that last year or month or week is not the
determinant of bond yields in the longer term. That advice is true
whether inflation is1% or 10%.
The longer term average of inflation is still probably at a
minimum in the 3% area. If real returns are to be 3%, about the
historical experience, the long-term Treasury bond should be
yielding over 6%, rather than about 4.75%. This simple math
suggests that bond investors are likely to lose a considerable
amount of money.
As a closing, let us consider the graph at the top left of this page.
The line of small squares is the year-to-year change in the Naive
CPI, produced each month by the government. That series
certainly looks like it is breaking out, and Wall Street is still
talking about deflation.
ADD TO GOLD POSITIONS:
Clearly we are out of space, and our opinion has not changed.
Current price weakness, created during the misconception that a
new bull market is starting in stocks, should be used to add to
positions or start new positions. Gold is cheaper than Gold stocks.
Be selective, seek value, and take care of my dog.
NED
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