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I have thought hard for a
long time about writing this article. There is a danger that it might spook a
lot of investors out of gold stocks and gold mutual funds altogether,
and therefore bring unnecessary loss to many people. On the other hand, this
one article will probably not be that influential.
I cannot shake the feeling that, during the first
part of 2008 at least, gold stocks will have a whale of a bad time. Yet,
nobody wants to address the subject because most so-called gold bugs are really
gold stock bugs. Nobody wants to scare their own customers away, but there is
a time when a warning is due, and I think hat time is now.
The problem is not that regular stocks are diving
right now, and that gold stocks will necessarily follow regular stocks. That
is simply not the case. As long as gold holds up and continues to rise, gold
stocks will have a floor under them, but it's extremely risky (and foolish to
assume that the floor lies right where the two gold stock indexes currently
are.
What's the Problem?
On the one hand, several main trends are converging
that negatively impact the profitability of gold miners in the near future. On
the other, there are only two "plus" factors that will support gold
miners - and then there is the wild card.
The negative trends are:
- Decreasing
ore grades across the world's gold mining industry;
- Depletion
of known deposits; (3) Difficulty in discovering new deposits to replace
depleting ones;
- Rising production costs
(fuel, transportation, inflation, etc.);
- Rapidly
tightening environmental restrictions on gold mining and a deteriorating
public image of mining companies as "nasty polluters", etc.
The plus factors are (1) gold is in a secular
uptrend that is in the process of establishing a new phase of steeper price
increases than those prevailing in the previous phase, and (2) the building
US and world economic slump that will have mainstream stock and bond
investors looking for safe and profitable places to seek refuge for their
money.
The Question
The question is: To what degree will the two
positive factors outweigh the five negative ones so as to prevent the gold
mining industry from going downhill, even as the metal itself becomes more
and more expensive in fiat currency terms, world wide?
Before we get into the subject matter, let's
establish what exactly we are talking about here. We're addressing the two
major gold stock indexes, the XAU and the HUI as well as gold mutual funds -
not individual mining companies not yet listed on any of the indexes. In other
words, we are looking at macro trends in gold mining.
First, the charts:
The HUI is below its November 2007 High but above
its 2006 High
... while the XAU is below
BOTH its November 2007 and 2006 highs.
Gold, on the other hand, is well above both highs
and very near its most recent closing-high of $905 per ounce.
Both the HUI and XAU are showing similar megaphone
patterns emerging (only the HUI's chart is shown
here because of the close similarity).
The days of the really steep HUI rises appear to be
over for now.
For any starting point after 2004-2005, the
comparison charts show the HUI to be no better than gold, sometimes worse, in
its percentage performance. The XAU has traditionally been gyrating around
the price of gold, although with a much wider amplitude on both sides.
 
However, more recently gold has had the upper hand,
and in view of the five negative factors pushing its stocks down, that is not
surprising.
Guess it all depends on how quickly the crash comes.
If people have time to prepare and think, and if it happens in stages and in
a somewhat controlled fashion, gold stocks will do well as long as people
have time to shift their assets around as the Dow and its associated plunge
downward. If the crash is sudden and catastrophic, having loaded up on gold
stocks will do little to ameliorate the disaster.
The problem is, none of us
know which way it's going to be, so the most sensible way would be to get out
and either buy gold for the proceeds or stay in cash and wait for the bottom.
Naturally, the smart thing for all gold stock
investors (as a group)
to do would be to sell stocks and buy gold. That way, the gold price is
supported and with that one going up, the stocks will do okay as well. Alas,
gold stock investors only act as a
group when they are either scared or greedy.
If you want to be "super-clever", you will
sell your stocks and wait for gold to consolidate after its drop and then buy
back in. That can be a gut-wrenching game, however. As we all most recently
saw, a gold consolidation period can last for a year and a half. Few will
have the inner fortitude to keep their cash dry during all of that time. Their
return-dependent investment fingers will be itching to put the money into something
else in the meantime so it can "work" for them.
The Wild Card - India
Indians are selling gold. From a fiat-oriented
perspective, it makes sense for them. India
isn't nearly as debt-laden as the US economy. People who had their
money in gold watched their neighbors brag about
general stock market gains many times those who held gold for years now. The
gold they once bought at much lower prices now fetches far more - so hey, why
not?
The problem is that even the kicking Indian economy
is still a fiat economy with all the attendant ills. It has a very export
dependent economy, with 17 percent of all exports going to the US, with the next largest numbers going to the
UAE at 8.3 and China
at 7.8 percent (CIA World Fact Book, 2006 numbers). Betting on continued
stock market gains of that magnitude while the US is going through a serious
economic "readjustment" would be rather foolish. Cash-strapped,
debt-laden, and unemployed Americans just won't have that much of a need for
outsourcing their services to India
- or to anywhere for that matter.
In any case, Americans had better wise up quick and
buy "physical." Gold and silver stocks (with the exception of stock
of individual companies with the occasional "big find") are just
not going to fare that well - not until everybody and their brother decides
that gold stocks are the only place left to invest in.
The point is: It doesn't make sense to stay in gold
stocks and wait for that time.
Gold stocks and gold mutual funds have their time
and their place, but now appears to be neither. It will make more sense to
redeploy money into them after the annual mid-year correction bottoms out. Monitor
subscribers will know when the time comes. Although there is still a chance
they may go higher again before then, at least to some extent, the downside
risks right now are just too great to justify.
As always, stocking up on physical gold is a far
better choice for long-term investment. No matter how far the illusory dollar
"price" of gold may sink, owning physical means you never lose your
entire investment.
Got
gold?
By : Alex Wallenwein
The Euro vs Dollar Monitor
Alex Wallenwein is the editor and publisher of the financial
newsletter, The Euro vs. Dollar Currency War Monitor.
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