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All That Glitters

gold

One of the most profitable investments over the past 10+ years has been gold.

It had a rocky moment in 2008 as you can see on the chart above when it fell to $680 an oz., but since then it has moved up to a new high of $1276 per oz., or almost doubling in two years.

There are multiple reasons for this move, but you can some it up to scarcity – this is really a supply and demand phenomenon and that dynamic is one that can provide investors with big returns if they play it right.

    Supply

– The production of gold (its mining and refining) has fallen by 12% on average each year for the past decade while the cost to produce it has risen to $500 per oz. Producers are not opening new mines due to the prohibitive cost and regulation but rather trying to buy up the mines of small producers.

    Demand


(1) In the developing world, buying gold – jewelry and otherwise – is a sign of wealth attainment. Gold purchases by the the burgeoning middle class in India and China are on the rise.

(2) The world’s central banks have as a whole shifted to buying gold, particularly those that have significant foreign currency reserves and little foreign debt (China, India, Brazil, the Emirates and others) as a way of diversifying away from the dollar which they see will likely be a declining store of value.

(3) Individuals and investors who view inflation as the most likely outcome to the developed world’s economic policies of easy money and currency debasement are stocking up on gold as a hedge against future losses.

So, with gold at an all time high, the question remains – is there still time to buy it or are we headed for a fall?

From a macro standpoint, the supply and demand dynamic dictates that gold will go higher over time. However, as with any investment, it can certainly get cheaper before it gets more expensive.

A San Francisco based hedge fund manager that I read points out that there are some natural support levels (his target for gold is $2300 per oz over the next three years): the 50 day moving average and the 200 day moving average are easily identifiable as well as the 2010 low and the 2008 low. You can spot each of those on the chart above. I think you can also view $500 (the average cost of production) as a floor – if gold falls too much, production will shut down with the most expensive ones first. As production capacity lessens, supply gets even tighter, and further supports the price of gold.

gold-ma-env

On the chart above, I’ve used moving average envelopes to overlay the price chart. Sometimes it is easier to see how a stock trades within a range in this view, and you can see that the mid-point and the bottom of the envelope have provided low risk entry points to establish positions in Gold.

A buying strategy for something that has move up as high as gold has, but which has definite downside support would be to slowly build your position on any pullbacks to the the support levels and low risk entry points detailed above.

Fortunately, we have had gold exposure in client portfolios for several years, both with the commodity itself through the ETF and through the miners.

Your decision if you do not have a position and want to start one (please note that this is not a recommendation to start a position or a recommendation for any sort of investment decision) is whether you want to own the actual commodity or the miners.

In your decision process, you have to take into account that the miners will be a higher velocity play on gold (meaning that their share prices should go up faster than the price of gold, all things being equal) however, they will also be impacted by the movement of the stock market in general and they have company specific operating and regulatory risks that can negatively impact share prices even if gold is rising.

Mark