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What is the Gold Market Trying to Tell Us?

Regular readers of this blog may or may not know that I follow the gold market fairly closely.  I am not a gold bug per se, but I do feel that gold is a decent store of wealth as opposed to the greatest investment as some would have you believe.  On the other hand, I don’t think that it should be dismissed entirely since it can have some purpose in a broad investment portfolio.

If you have been watching the gold market recently, you have probably noticed that the price has dipped below $1600 per ounce.  The gold market has historically been one that has been responsive to inflation expectations due to money supply or geopolitical concerns or even financial crises and a loss of confidence in fiat currency.

But with the gold price having backed off from a high of over $1900 per ounce last August and September, is there something that we should be expecting?

Global Industrial Slowdown?

Here is a recently published article that suggests gold is correlated with global industrial production.  That would seem to make sense as inflation, while technically a monetary phenomenon, seems to respond as a result of increased demand as well.  When the labor pool is tight, wages increase leading to a broad increase in prices.  Likewise, when the cost of oil and transportation and all the other goods that use oil in production increases, the gold market seems to respond to those inflation expectations.

If this is the case, one has to wonder whether the gold market is foretelling some global economic slowdown.  Is there another recession on the horizon?  Is China slowing down and are concerns about growth coming from that area of the world?  Is Europe really going to become a major headache?

On the other hand, is it simply the fact that there is no sign of inflation in the near future and that growth will continue albeit at a more moderate pace?  Is this simply a period of consolidation in the gold market?

There is a seasonality to the gold price and summer tends to be a slow time in regards to the price.  Is this a factor in the current pull back?  Will the price for an ounce of gold make another strong run in the fall?

To be perfectly honest, I really don’t have a clue.  So, what am I doing with this information?

Buying More Silver Wheaton Stock

I am buying more Silver Wheaton stock.  Silver typically follows the gold price although with some added volatility.  This has provided me a decent opportunity to purchase some more SLW which should make a nice rebound should seasonal factors be playing a role or should global economic activity improve.

I have already increased my share count by 6.5% this past month and am looking to add some more when I sell some calls and collect the premium.  Hopefully, I will have enough cash to do this during June.  I should be collecting some dividends from Seadrill and AK Steel during the month of June so that should help with the needed cash.

The key will be to maintain patience and add to positions when the stocks are down and pare back when they spike.  I plan on using the same technique with Silver Wheaton and by extension, the price of gold and silver.

What do you think is happening with the gold market?



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8 comments - What do you think?  Posted by Cash Flow Mantra - May 11, 2012 at 12:33 pm

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Buy Your Gold Now Before Summer 2012

I ran across an article last week that adds additional credence to my concern that China has declared economic warfare on the United States.  Of course, China will not come out and say it, but what better way to increase your country’s standing in the world than to become the dominant economic force and begin controlling the world’s resources.  Money talks and can buy a lot of technological know-how, and China has over $3 Trillion now.

China has already been using its cash horde to purchase as much oil as it can get its hands on.  But now it is going to be going after the gold market as well.  After all, if you had $3 Trillion just sitting around, would you be buying US Treasuries that yield next to nothing?  Or would you be securing tangible assets for your country’s citizens to allow them a better lifestyle?

Surprised by the Gold Market

I was actually quite surprised (although not entirely) that the Chinese would develop a market for gold.  It was only in 2003 that China allowed individual ownership of gold and now less than ten years later, the market will begin to open up for all its citizens giving them the ability to buy gold in their local currency.  As stated in the article, this is a scary thought.

I am sure that any rules that the Comex tries to enact will matter little to the Chinese.  The government will continue to produce gold and buy on the world market whatever amount of gold is necessary to satisfy the demands of the people.

Theoretically, this means that the gold price will rise from its current levels since the potential demand for gold will be increasing dramatically.  Of course, there is always the possibility that demand will not be there.  Even if it is possible for millions of people to invest in gold, will they?  Would they rather join the middle class and purchase iPhones instead?  Would they prefer to have consumer goods like appliances and televisions rather than a hard asset like gold?

Impossible to Predict Markets

It is impossible for me to predict the impact that this information and development will have on the price of gold.  Personally, I think that gold will surpass $2000 per ounce in the next 24 months.  I have previously shared my thoughts on investing in gold and would reiterate that holding some exposure to gold (5-15%) in a balanced portfolio is a prudent idea.  I am not currently adding to positions but am maintaining my current exposure to precious metals with my investment in Silver Wheaton stock.

I hope that I am wrong and that the price of gold collapses back to 3 digit territory.  That would mean that purchasing power of the dollar has increased dramatically and my cost of living would have accordingly decreased.  The price of gasoline would likely be down as would the cost of food.  Economic prospects would likely be much better than they are now, and the stock market would be rising.  That type of scenario would be great with me, but I really don’t see it happening any time soon.

I suspect that interest rates will remain low for the next 18-24 months.  Ben Bernanke has already said that rates will remain low until 2013.  It will be summer of 2012 when the Chinese gold market opens up.  I think this could be the necessary catalyst to propel gold past $2000 per ounce.  There will be some speculation involved I am sure but that is not unusual nowadays.

Buyer Beware

The bottom line is that this article was just another piece of a great puzzle causing me to think and consider what might be in store for the price of gold over the next few years.  I certainly wouldn’t be jumping in with both feet, but will consider whether or not this recent $1600 level for gold or $30 level for silver might just present a buying opportunity.

Readers:  So what are your thoughts?  Do you think the Pan Asian Gold Exchange will have a significant impact on the gold price?  Are you investing or have you invested in gold?  How will you be investing over the next year or two?  Feel free to comment.

12 comments - What do you think?  Posted by Cash Flow Mantra - October 7, 2011 at 3:00 am

Categories: Investing   Tags: , , , ,

Lessons in Diversification

Warren Buffett has two rules for investing:

Rule 1:  Don’t Lose Money

Rule 2:  Never Forget Rule #1

I like those rules.

I mentioned several posts ago that I used protective put options against all the stocks in my portfolio and broached upon the subject of diversification.  But that really begs the question: “What is diversification?”

By definition, diversification is a technique of reducing risk by investing in assets that have poor correlation so that when one investment declines, the other declines less and will decrease overall risk.

The other method of reducing risk is by hedging which is what protective puts are doing for me.  Hedging techniques work to reduce risk since the assets have negative correlation.  When my stocks decline in value, my put options will actually increase in value.

A general tenet of investing is that increased risk should lead to increased returns.  Therefore, one can conclude that by reducing risk, both diversification and hedging will decrease the overall return of a portfolio.

However, one must remember that it is more often avoiding large losses that leads to investment success rather than getting large outsized gains, just like too many unforced errors in tennis or turnovers in football lead to poor outcomes.

Correlation of Assets

One of the basic tenets of modern portfolio theory is the correlation between different asset classes.  The goal is to maximize overall return of the portfolio while minimizing risk through asset allocation.  When one portion of an investor’s holdings decreases, another portion will increase.  The actual mix of asset classes becomes more important than any one individual asset selected.

One of the best sites that I ran across while doing some research for this post is a correlation matrix.  There is no good way to reproduce it which is why I provided the link.  It shows the correlation between different asset classes as represented by the three month return of the exchange traded funds representing the asset classes.

As you can see over the past three months, inflation-protected Treasuries (TIP) and gold (GLD) have been positively correlated.  This makes sense since gold is typically thought of as a hedge against inflation.  You can see that stocks whether large cap or small cap or international stocks have been positively correlated.

Correlation Volatility

One has to remember that there are times when historical correlations deviate from the norm such that asset classes that may not have been very correlated move in tandem.

If we look to 2008 as a recent example of market instability, we can see that many asset classes lost significant value.  However, I would point out that there was a major difference between returns on bonds other than high-yield and stocks.

Despite commodities in general losing money, gold had a positive return.  So even though correlation values may have changed during that time frame, the general trend remained intact such that TIPs lost very little and were negatively correlated to equities.

I would like to leave you with one final link.  It is a great article that discusses asset allocation, having a healthy investment mindset, and the importance of time in investing.  I think this is one of the major takeaways that all investors should get from this discussion.  Invest early and invest consistently through good times and bad.

If you can remember that, you can’t help but make money.



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8 comments - What do you think?  Posted by Cash Flow Mantra - September 13, 2011 at 6:20 am

Categories: Investing   Tags: , , , , , ,

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