Many May-Investments clients have owned gold and precious metals investments, through mutual funds, exchange traded funds, or individual stock positions since March of 2009. While positions may have been sold and repurchased in the interim, generally speaking we have been owners of gold for the past four years. We have even more reasons to own these companies now than we had originally.
In 2009, gold stocks were going up and the government was running the printing presses on overtime, igniting concerns about dollar-devaluation. Since then, the price of gold has increased, earnings throughout the sector have generally increased, and the psychology has shifted from positive to greedy and now to extremely negative. From a valuation perspective, too, it is much easier to make the case for gold, today, than it was in 2009 (when just about everything was cheap). Today, gold is like a relic from 2009; while some other asset classes have doubled off the lows, gold mining stocks languish back at 2009 prices.
One thing that is abundantly clear now, however, that wasn’t as apparent in 2009 was that gold doesn’t respond well to our normal trading rules. In August of 2009, we sold our position for a modest gain because gold was lagging other parts of the market, which were rallying quite a bit. Only three months later, gold more than caught up and we bought back in, at a much higher price, at which point gold once again took a breather. While momentum hasn’t worked all that well, anywhere, in the past couple of years, it has been particularly dangerous to gold investors.
In the summer of 2012, it was clear that our discipline was telling us to sell gold again. We hung on, and in the third quarter of the year gold soared higher, moving so quickly that gold moved from the bottom performing asset class to the top spot for the quarter, up more than 30 percent in only three months. As it turned out, rather than a “buy” signal – this would have been a “sell” signal for gold. Since then, the gold Exchange Traded Fund is down nearly 30 percent. Had we sold in June and bought back in, in October, we would be much worse off. Trading gold, using our traditional trading rules, would have been a very costly mistake.
Instead, we are forced to make a longer term decision about keeping gold, or selling it.
One of the original reasons for buying gold miners still applies. More than ever, the U.S. government continues to print money so aggressively that it is hard to imagine it not resulting in currency devaluation. Throughout history, many governments have tried to print their way out of a financial crisis, convinced that ownership of a printing press is a license to overspend, but none yet has managed to avoid paying consequences for unrestrained monetary growth. Moreover, in 2009 it was mainly the U.S. government that was experimenting with this new theory of “Quantitative Easing.” Now, Europe and Japan have jumped on the easy money bandwagon, too.
After this new bear market in gold stocks, the gold mining companies now sell for about the same price as they did amidst the Great Recession of 2009. The price of gold, itself, which is the source of revenue for companies that are in the business of converting gold reserves into precious, shiny metal, is actually worth about 70 percent more than it was in 2009. While no longer selling at its peak, the metal itself is worth significantly more than it was when we first bought into gold mining companies.
Not surprisingly, given the rise in the value of what is stored in the basement of gold mining companies, the companies themselves are far more profitable than they were back in 2009. Earnings in the sector, generally, have tripled since early 2009, when we first invested in these companies. In spite of this, their stock prices have done a round trip back to 2009 levels.
Compare this with the stock market, generally, which has appreciated significantly since 2009 and now sells for roughly 15-times corporate earnings power. Gold miners, however, are currently valued at only about 10.6-times earnings. Comparing gold companies to the broad stock market, the gold stocks sell at a cheaper valuation and are about as uncorrelated to stocks as anything else out there, making it a good diversifying investment for a growth portfolio.
Another popular asset class is inflation-protected Treasury bonds, which promise to pay investors a certain rate of interest in addition to ratcheting up bond principal to keep up with inflation. In the long run, gold is also likely to keep pace with inflationary pressures. However, according to the Baseline gold miners industry index the gold stock sector is comprised of stocks paying an average dividend yield of about 3.5% per year, while 10-year TIPS bond yields are negative (about -0.61% at the most recent Fed auction).
Inflation protection and yield are things that everyone seems to want, unless it comes in the form of a gold miner stock, in which case the current bear market psychology trumps every other investment attribute.
The speculative fever in 2011 popped when the U.S. economy failed to succumb to political gridlock and resumed its growth pattern. The number of speculators in the gold futures market is down significantly from the excitement that accompanied gold’s spike to $1,900. The net positions of large futures speculators have been cut by 45 percent, while short interest in the gold futures market have increased as speculators reverse the bullish bets made only 18 months ago.
In the meantime, real demand for gold seems to be holding up. Ned Davis Research group believes that central bank buying by the People’s Bank of China accounts for a lot of this demand for real gold. About the same time that China’s central bank stopped investing in U.S. Treasury securities, demand for gold spiked higher. Their thought is that, “the desire to own physical gold (strong hands) remains solid, in contrast to paper gold (weak hands).”
Essentially, by March of 2012 my gold investment feels as contrarian as my skepticism about tech stocks in 1999, my concern about a real estate bubble in 2006, and my interest in junk bonds at their nadir in 2009. We’re in the midst of a vicious bear market for gold companies. And if a bottom can be called based on the degree of pain experienced by “long and wrong” bulls, the bottom has got to be close.
A recent “Seeking Alpha” article expresses a technical case for gold and gold stocks making a technical bottom. Please be aware that the author’s views do not necessarily represent May-Investments view, but many readers of this blog will find this article of interest. Furthermore, that author talks about specific investment securities which are typically not owned by May-Investments clients. We don’t typically like to blog about specific securities, but found the article of interest in how it discusses the possibility that gold is at a bear market nadir.
So is this a great time to add to our existing positions? That’s the problem with bear markets. They are particularly vicious in their last days, which makes bottom fishing tough. The ferocity of this sell-off remind me a little bit of 2008, when one of the first indications of big problems around the corner was a nightmarish sell-off in international stocks and commodities. It might be that the commodity bear market is just an indicator that it’s a good time to sell, everything else. Hopefully not.
The recent sell-off also correlates to a short-term boost in the value of the U.S. dollar, particularly versus the yen and the Eurodollar. Maybe the sell-off in gold just means that the other currencies involved in Quantitative Easing are blowing themselves up? Whatever the case, the weakness in gold accounts for a great deal of my grumpiness, of late, particularly as other parts of the portfolio surge to new highs.
At this point, we’ve re-experienced a bear market in gold and gold mining stocks, and to some degree in commodity stocks, generally. It is important to recognize the grinding pit in the stomach that accompanies a bear market, because often times that is the signal that it’s time to buy. If so, it’s time to buy the gold mining stocks. My main regret, of course, is that they are already in the portfolio. So it seems like a poor time to cut bait and run.
It took less than 6 years for the bear market in U.S. stocks to round-trip back up to 2007 highs. My guess is that we’ll see new highs in the gold mining stocks long before 2019. The reason that gold doesn’t trade well is because it is so volatile. For the past 18 months, we have experienced the downside of volatility. Looking forward, I think it’s high time we once again enjoyed the upside volatility that gold and other commodities can deliver.
If the stock market is right, and it is signaling continued economic expansion, then we ought to be cycling on into the late stages of economic recovery, which is identifiable by rising interest rates and higher commodity prices. If so, better times for gold could be right around the corner.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .
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