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Gold's big run is almost over
Golds good for jewelry but a terrible investment right now. One ETF has engorged the market with investors, and the price is unlikely to rise much higher.
By Timothy Middleton
When an investment skyrockets in a short period, the first question most of us ask is: Is the party over? For gold, my bet is that it is.
The party ended a week ago yesterday. Having reached a 25-year high price of more than $570 an ounce that Monday, the price of gold bullion began a two-day, 5% tumble that left gold at $544. Toward the end of the week the price was rebounding, but not to its peak level.
The story of golds meteoric rise is largely due to the popularity of a single exchange-traded fund, StreetTracks Gold Trust (GLD, news, msgs). Launched just 15 months ago, by the beginning of this month it had attracted assets of more than $6 billion.
Since shares in the trust represent ownership of one-tenth ounce of physical gold, the trust is sitting on 343 metric tons of the stuff, more than the Bank of England -- indeed, more than all but 16 of the worlds central banks.
The ETF has more assets than the next five largest gold mutual funds combined, and is the world's largest trove of gold in private hands. It dominates its marketplace more completely than any comparable investment portfolio. Among technology funds, for example, no single fund is bigger than even two of its biggest rivals.
This is a big chunk of global demand -- 13% or 14% of annual mine supply, says John Hathaway, manager of Tocqueville Gold (TGLDX) fund, of the ETFs bullion holdings. All by itself, the ETF shouldered aside typical factors affecting the gold market and became the big driver of golds price. Traditionally, jewelry demand and hedge-fund speculation were the culprits.
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Bullions price also surged upward because gold producers decided four years ago to stop hedging their future production, or selling next years output at todays price.
Mark Johnson, manager of USAA Precious Metals and Minerals (USAGX), says this months peak in the metals price will mean that the temptation to hedge will become overwhelming for some of these people, and in fact youll see hedging come back. That would be a negative for the gold price.
If you own gold, this looks to me like a swell time to sell it. If you dont own it, I sure would not be a buyer.
Why gold stocks should go higher
So far in February, gold stocks are down about 12%. That gives investors a chance to get in before the next move up. Click here to read Jubaks perspective on gold.
The guns-and-bacon portfolio
Long-time readers know that I have no use for gold, except to adorn my wifes wrist. If you want end-of-the-world protection, shotgun shells pack more punch. If you like commodities, pork bellies are tastier.
Aside from the fact that gold is to the human eye what tinfoil is to a magpie, it pays no interest, costs a lot to protect from thieves, consumes nearly as much energy to mine as it is worth by weight and is more pollution-intensive than any other extractive manufacturing process.
And in the latest rally, gold has also lost any semblance of fulfilling its traditional role as a hedge against inflation and the depreciation of paper currencies. While gold has gone up more than 35% in the last year, inflation has barely budged and the dollar has actually strengthened.
By making it possible for investors, from your brother-in-law to your insurance company, to invest in bullion economically, the ETF has been responsible for most of golds appreciation. Economic prosperity in India and China, two cultures that value gold highly, has also paid a role. So has recycling of petrodollars, since rival investments, from Treasury bills to blue-chip stocks, have offered no competition at all.
Central banks are the swing players in gold market -- U.S. gold reserves alone are worth about $163 billion -- and have not played a big role recently, either by dumping reserves or adding to them wholesale. Only Russia has publicly announced plans to bolster gold reserves substantially.
Too many gold fans
Meanwhile, gold producers have hit a cost wall. Their single biggest expense is energy, so their profits havent risen in line with the price of bullion. Assuming energy prices dont rise this year as much as they did last year, mining companies profit outlook would improve, except that the gold price appears to be condemned to taking a pause.
Before last weeks correction, You had a very overbought market, says Hathaway, using Wall Street slang for unwarranted exuberance. You had a bullish consensus over 90%. If that isnt a red flag, I dont know what is.
So he predicts golds pause will continue. For the market to make its next move it needs to be on firmer ground, he says. Sentiment has to be more subdued that it has been.
Hathaway is paid to worry about the price of gold, but I am not. Gold makes a great wedding ring but a lousy investment. At todays levels, gold is trading where it was in 1981, when the Dow Jones Industrial Average ($INDU) was around 700. If the Dow was still 700, you wouldnt call stocks an investment, would you?
Gold is a speculation, and it looks to me like a poor speculation now.
At the time of publication Timothy Middleton didnt own any securities mentioned in this article.
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