The golden mystery

Posted: October 23, 2008, 2:01 PM by Jonathan_Chevreau at national post

These must be frustrating times for gold bugs. For years they’ve been waiting for financial armageddon and now that it appears finally to have arrived, the price of gold bullion and gold stocks is plummeting with most stocks and commodities, even though most suppliers of gold coins don't have enough on hand to meet demand. Something strange is happening.

All of which doesn’t stop John Embry, chief investment strategist at Sprott Asset Management from declaring in the Oct. 17th issue of Investors Digest that the U.S. government’s “Rescue will send gold to surreal price level.”

Embry should know about surreal prices. As an owner of Sprott Precious Metals myself, I can confirm the fund is trading at surreal levels – surreally low. There's a big difference between physical gold and the stocks of gold miners and exploration firms. I never thought we'd see gold in the low 700s in this kind of global crisis but if you're in the "5% gold as insurance camp" as are some investment advisors (for example at Rogers Group Financial), then the better play might be the SPDR Gold Trust [GLD/NYSE].

Go to the Gold-Eagle site and you can see various explanations for why gold hasn’t soared as it should have – most revolve around the fact there is a “conspiracy” to suppress the gold price by the central banks, governments and other members of the “fiat” or paper money cartel that rules the world.

Maybe there is, in which case gold could go even lower. You have to hand it to the “fiat” crowd – keeping a lid on gold during the Great Credit Crisis of 2007-2008 is some kind of accomplishment. I borrow that phrase from David Smick, whose The World is Curved published last month should be a must read for investors concerned about the many hidden dangers to the global economy.

I don't count myself in the "gold bug" crowd but am familiar with the arguments. Once upon a time a dollar was backed by gold and in theory you could trade paper dollars for the gold the paper promised. That era was ended in the early 1970s by Richard Nixon and with the exception of the Islamic Dinar, most developed nations run the printing presses with little concern for the fact their paper money is backed only by faith. The U.S. and other developed economies are essentially adding zeros to their computers somewhere in order to create liquidity -- in theory, what they're doing is no different than what Zimbabwe is up to. The difference is Robert Mugabe can't get away with it and so that nation is afflicted with runaway inflation. The U.S. is more subtle about it and the U.S. dollar has actually been moving up in recent months even as gold languishes.

As commodities expert Bob Tebbutt commented today in his daily market update, “Lead should be a buy along with Gold but the general market panic selling is not helping any fundamentally strong market situation. Gold may be the best bet on the board but not when it is declining as fast as it is now.”

Consider too what Larry Swedroe says in his just-published The Only Guide to Alternative Investments You'll Ever Need. Swedroe classifies precious metals equities in his "flawed category" -- behind "The Good" but ahead of "The Bad" and "The Ugly." He concedes PMEs do provide a good hedge against inflation and "there could be a large rebalancing (diversification) bonus" but says for the latter PIMCO's Commodity Real Return Strategy Fund (or an ETF or equivalent) is a better alternative than bullion funds or precious metals equity funds.

Consider too what columnist Jane Bryant Quinn wrote this week: Gold only good for maximum despair. She notes that buying physical gold as insurance against a currency collapse is a rich man's game and warns that "gold isn't even a reliable hedge against inflation." Note too her comment on the GLD ETF: that "you don't own the gold directly."

BMG Bullion Fund [aka Millennium Bullion Fund] does hold precious metals for you, but you have to take equal parts platinum and silver with your gold.

Where do I sit currently? I've always been in the "5% insurance camp" and if the gold price keeps dragging down the value of precious metals funds below the 5%, at some point it may be necessary to "rebalance" back up to 5% by taking profits from some other asset class. But there's the rub: find me an asset class that's in the plus column right now.