Gold limped above the $1,000-an-ounce threshold again this week. The foray into four-digit territory lasted barely a day, but it was long enough for the metal’s fetishistic advocates to make their usual case for a quick run to much higher prices.
They showed gold to its best advantage by cherry-picking economic data and lessons from history. An evenhanded look at the evidence suggests, however, that selling gold at around a grand an ounce makes more sense than buying it and that selling shares of mining companies is an even smarter move.
Fringe-dwellers in the pro-gold camp express skepticism toward any asset made of paper. They find the world a perilous place forever on the verge of anarchy and hyperinflation, where gold will be the only recognizable item of value, except maybe for a Rottweiler or a bazooka.
Even the more serious, reasonable bulls are prone to fits of hyperbole. Andy Sutton, writing on the Seeking Alpha website, for instance, calls gold “the opportunity of a lifetime,” pointing to the weak dollar, the prospect of runaway inflation as the U.S. fiscal deficit balloons and a stock market that he contends is rallying only within a prolonged bear market.
The deficit argument is something of a red (ink) herring. The deficit will add trillions of dollars to the economy for a while, but many more trillions were lost in stocks and real estate. With consumers reluctant to shop and eager to pay down debt, inflation looks likely to remain low - if it exists at all. Peter Cohan, in a post on AOL Finance mocking the gold bugs, notes that inflation is nowhere to be found. Consumer prices have fallen in the last year, he writes, and they are expected to rise by less than 1 percent next year, despite the deficit. Alan Heap, an analyst at Citigroup, also highlights receding inflation pressures. He argues in a recent report that returns for gold should be uninspiring; he foresees prices averaging in the $900s for a few years before dipping to $890 in 2012. The higher interest rates that Heap anticipates in many economies will do gold no favors; gold earns nothing, so high rates relative to inflation are bearish for the metal. Another factor limiting gains is reduced demand for coins, bars and other types of physical gold. The futures market nevertheless shows extremely high expectations among speculators for a continued rally; 90 percent of large speculators report being bullish on gold, a similar proportion to March 2008, when the price reached its all-time high of $1,034. By contrast, just 22 percent of commercial traders are bullish. That’s a bad omen for the bulls. Commercial traders in any commodity market are regarded as smart money because they are intimately familiar with industry supply and demand, now and months into the future. Speculators instead tend to trade on emotion or an amateur’s knowledge of market dynamics. Years of data show that when a wide discrepancy exists between the positions of commercials and speculators, it’s almost always wise to be on the side of the commercials.
If this is a good time to sell gold, it should be a better time to sell mining stocks. The mining industry is notorious for its poor business acumen, which results in weak profit margins, an inability to benefit fully from high gold prices (due to higher production costs) and weak share price performance.
A look at long-term returns confirms that. Gold stocks represent an investment in gold and in the stock market, yet they do a lot worse than either.
Since the end of 1983, gold bullion has risen about 160 percent, while the Standard & Poor’s 500-stock index is up more than 500 percent, even after the worst collapse in nearly 80 years. As for gold stocks, the widely followed PHLX Gold/Silver Sector index has doubled since November, but that only gives it a gain of 70 percent or so over the quarter-century.
If you own mining shares, you may want to consider selling at these prices. The same goes for physical gold, although it’s reasonable to keep a bit as head-for-the-hills money in a crisis. With gold running up against levels from which it has always turned back, the stock market rally looking tired and mining shares perennial losers, this is the time to cut exposure to gold, not add to it.
