The Harsh Truth About Gold
Is gold dead?
Over the last three years, the SPDR Gold Shares ETF (GLD) has lollygagged in a sideways direction.
I’d honestly rather watch paint dry than analyze a gold chart.
Given such an uninspired performance, I don’t believe that gold warrants a major weighting in your portfolio.
Of course, my assertion above constitutes sacrilege to any “gold bug.”
So let me explain…
Please don’t confuse a gold ETF with owning physical gold.
A gold ETF is a piece of paper that represents a loose claim (at best) on gold.
Vaulted gold, however, is real — and can be called upon in any crisis event.
Still, some folks will insist on owning proxies for gold, rather than actual gold bullion.
If you’re among those who favor paper gold, don’t simply buy an ETF.
Below are three more intelligent routes into gold.
An Alternative to Owning Gold
While the Fed prints money like confetti, it’s important to gain some exposure to gold.
As Louis mentions above, ETFs are not a suitable way to do so.
Gold ETFs suffer from a tracking error against physical gold’s price. And that error can increase if the gold price zig-zags violently.
But even physical gold has its drawbacks.
Physical gold yields nothing. It incurs storage costs. And it’s difficult to sell for full value when you need cash or your gold view has changed.
So what’s the best route into gold investing?
Buying shares of carefully selected gold mining companies.
Gold mines offer the following advantages over owning gold or gold ETFs.
- They earn money each year, and many pay dividends.
- They are leveraged. So if gold doubles, mine shares should do much better.
- If they have good exploration teams, their gold reserves per share will increase.
Of course, there are some pitfalls to watch out for that can offset these advantages…
For instance, some mines have very high mining costs. Or they can be located in politically risky areas. Or the mines can be close to depleted.
But when you isolate a mining play that’s free of these risks, you boost your chances of a homerun.
One substantial mine that’s on my radar is Agnico Eagle Mines (AEM).
The company boasts good reserves, low costs and little political risk.
AEM has mines in Canada, Finland and Mexico — all solid jurisdictions. (Aside from the risk of snow in Canada and Finland, of course!)
In the second quarter, its all-inclusive sustaining cost of production (AISC) was $785 per ounce, $500 below the current gold price. It’s profitable, with earnings reaching $0.27 per share. And it pays a quarterly dividend of $0.10 per share, to yield 0.9%.
In August, it increased its production guidance for the year to 1.62 million ounces. While its Meliavit project in Nunavut territory, northern Canada, with 3.2 million ounces of reserves, should come on stream in 2019.
One-Stop Shop for Gold Miners
Outside of possibly reducing the volatility of a portfolio, owning shares of GLD doesn’t do much for investors.
The precious metal has largely underperformed stocks during this incredibly resilient bull market.
But as inflation picks up around the globe, gold stands to shine brighter than pricey stocks and bonds.
Paper gold ETFs like GLD won’t capture the coming gains, but gold miner ETFs will.
As Martin noted above, miners are leveraged to the price of gold. So they will outperform the metal as its rises.
But not all investors are comfortable in picking single stocks.
An ETF like the VanEck Vectors Junior Gold Miners ETF (GDXJ), though, offers investors a piece of the world’s smallest, most explosive miners.
Over the last two years, GDXJ has soared 60% as gold has come back. During the same period, GLD has gained just 10.4%.
Bottom line: If you’re after upside in gold, paper gold ETFs aren’t worth the time of day. But gold miner funds will soar as the precious metal pops.
Supercharged Gold Gains
Gold shines most when inflation rears its ugly head. And there’s increasing evidence that an uptick is right around the corner.
After enduring years of sluggish growth, the global economy is projected to increase by 3.6% this year and 3.7% in 2018.
“Inflation will start to come in that environment,” says Bank of England Gov. Mark Carney.
Indeed! And for those who loaded up their portfolios with gold nearly a decade ago, on the expectation that historic central bank intervention would lead to hyperinflation, it’s about time. They’ve been earning virtually nothing on their “sure thing” gold investment since then.
I’m not here to heap on the criticism, though. Instead, I want to share a third way to invest in gold. This one represents a way to supercharge your gains to make up for lost time — or to reward those who knew better to wait.
I’m talking about buying just out-of-the-money long-dated call options on the VanEck Vectors Junior Gold Miners ETF that Jonathan shared above.
You can go out as far as January 2019 right now.
Doing so effectively gives you double-leverage to gold prices.
First, by owning the gold miners — which typically rise faster and higher than the metal itself. And second, by purchasing options — which amplify the price movements of the underlying asset (in this case, the miners).
Some would argue this is a much more speculative way to invest in gold. But I disagree.
Gold should only account for a small percentage of your overall asset allocation (no more than 5%). Instead of tying up all that cash indefinitely, you can limit your outlay by purchasing the options, which also limits your downside risk.
In the end, this small amount of capital can go a long way to make up for lost time and/or make a fortune in a short period of time. Or it goes nowhere, just like gold has done for years.
In other words, it represents a lower risk, lower cash outlay (and higher reward) gold trade in today’s market.
Ahead of the tape,
Chief Investment Strategist, Wall Street Daily