Gold/precious metals

The answer to your question depends largely on your age and time horizon for holding. I recently bought precious metals for the first time in my life. I'm in my middle 30s, and intend to hold for a long time. Like yourself, I was concerned about the possibility of short term dip, or, considering how well the metals have held up, buying at the top of a bubble. In the end, I decided to take that risk.

I believe the longer term prospects for precious metals are very bullish. I have complete confidence that politicians, who can't think beyond the next election, will continue to print money, so as to be seen by the public as "doing something" about the problem of the day. If you agree with me on this point, it's as simple as economics 101: increase the overall supply of dollars, their value as a unit of purchasing power will decline. It's only a matter of time.

Anyhow, there's my short and sweet answer to what's really a much more complicated question.

BTW, I bought Central Fund of Canada (CEF.A) I like the fact that it's a mix of gold and silver. The physical bullion is independently audited at least once per year. (at least that's what it says in their prospectus) Hard core gold bugs deride ETF's as "fools gold."

Alexandra - I'm not so sure that gold prices are "high" at the present time. I'm acutely aware of the fact that gold has done very well over the past decade, which is one of the reasons I decided on CEF.A - the silver component. I'm concerned that the fiat currencies of the world
are what's really overvalued at the present juncture. I agree with you about oil. This is something I'm looking at. It's not a question of whether or not oil will rise, it's only a question of when, and, by how much. Double bonus, the energy industry allows you to earn dividends while waiting for capital appreciation! As a younger person, inflation protection is my #1 concern at this time.

Canadian Capitalist - you make a great point about the fact that most broad based Canadian equity funds provide plenty of exposure to our mining sector. My problem with these funds is that they all have exposure to the financials. Despite all the talk about the relative strength of the Canadian banks, and, the great dividends, I'm still leery of the financials. I would agree that the mining stocks provide leveraged exposure to the sector. This is something worth considering. My current thinking is 15-20% of total assets allocated to precious metals sector, roughly 50% of that bullion, the other 50% mining stocks/etfs.

People generally hold gold as an inflation hedge, i.e., even if inflation goes through the roof, gold should still hold its value. Over the long run though, the expected return to holding gold, after adjusting for inflation, should be close to zero. There are some factors that can drive gold up or down in the short or medium terms, but generally it is a just another mineral we dig out of the ground that for historical reasons happens to have some value.

Some of the key influences on the price of gold include:
-The volatility of the market/economy;
-Inflation;
-Interest rates;
-Gold consumption (like demand for jewelry);
-Gold output from mining firms;
-Gold purchases or sales by central banks; and
-Gold purchases or sales by other investors.

Central banks don't hold as much gold as they used to, but they still hold enough to supply short sellers. There is no shortage of gold to borrow and sell, which is why gold futures are always in "contango" (the further into the future one looks, the higher the price is). This does not necessarily reflect the expected future value of gold so much as the arbitrage relationship that exists between gold in the spot market and gold futures. There are ways to profit from trading gold-linked securities (best discussed elsewhere at another time), but holding naked long positions in the physical commodity is not typically considered to be one. If you do profit from holding physical gold, you are really just making a speculator's return, which you could have earned investing in something else.

If you are looking for an interesting story about metals trading, try looking on Google for "Hunt Brothers" and "Silver".

somecatchyprase said:

Robillard - You make the point that gold futures are always in contango. Wouldn't this be true for all commodities, all the time? Common sense would suggest that futures prices would always have a risk premium versus immediate delivery.

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Actually, only certain futures contracts are always in contango. Some contracts are often in a state of backwardation (where the future price is below the current spot price). The main factor that governs whether a contract trades in contango or backwardation is whether there are stocks of the underlying commodity or security that can be borrowed and shorted. Gold is always in contango because central banks and certain investment funds have built up stocks of it that can be borrowed and sold. If there was no gold to short, then traders would not be able to pull off arbitrage trades, and it would likely trade in backwardation.

Some commodities almost always trade in backwardation, such as copper. This is because there is a lot of demand for immediate use of copper and there are little to no stocks of it available to borrow and short. If there were such stocks available, traders could borrow and short copper at the spot price and buy it back at the futures price, making an arbitrage profit in the process.

Unless there is some reason to think one's counterparty can't or won't deliver, I can't think of a reason why there would be a risk premium embedded in the price of a futures contract. The contract, after all, gives one price certainty. The spot price can fluctuate, but often the best guess of the spot price in the future is the price of the futures contract.

CanadianCapitalist said:

I don't understand investing in commodities like gold and silver. These commodities can be expected to have a long-term return rate of 0. That's worse than cash and bonds and much worse than equities.

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I completely agree.

There's another practical reason to question any investment in gold and silver: from a physical perspective, are they really worth their value?

70% of gold is used by the jewelery industry; a good portion of the remaining 30% is used in electronics. From an electronics perspective, there are numerous viable alternatives to gold, so it shouldn't be viewed as the only recourse for low-resistance conductors.

15-20 years ago, the vast majority of silver consumption in the world was by the photographic industry (part of the chemical compounds for finishing photographs). Nowadays, the demand for printed photographs is greatly diminished, and silver's value as jewelery is superseding its "practical" value.

I like to think back to a question that Buffett once posed in a letter to shareholders. Paraphrasing, he asked: what would aliens think if they came to earth and saw us assigning such high value to such otherwise benign metals? From a physical perspective, it seems odd to think that gold is worth more than many other, more imminently useful materials.

And this is why I largely avoid investment in assets that don't make "sense" to me on a physical basis. e.g., I hold quite a lot of oil assets in my portfolio, because I see a practical value in oil, but I refrain from investing in gold.


K.

Gold isn't for everyone. Stick to what you understand and you'll do fine.

Imo, gold isn't "hot" yet. Average joes are selling, not buying.

I would advise against ETF's (ie. GLD, SLV) that claim to hold physical gold and silver for you.

I would suggest:

-physical bullion
-royalty companies like SLW, FNV (little exposure to mining risks)
-good junior companies with cashflow, no debt, good management (if you know how to pick em)

Gold supply won't be increasing significantly as the price continues to soar (there's only so much gold to find) so I expect companies to increase dividends.