JakilaTheHun (99.93)

Is Gold Vulnerable?

October 08, 2009 – Comments (7) | RELATED TICKERS: GLD , GOLD , ANV

Is Gold is Vulnerable?

From September to November of last year, I went on a gold spree here on CAPS.  I green thumbed gold miners.  I green thumbed gold ETFs.  I green thumbed leveraged gold ETFs.  And I probably even red thumbed some ETFs shorting gold.

Given the uncertainty in the market and inflationary fears resulting from government policies of Bush II, Congress, and potentially Obama, I felt like gold was a good safety vehicle.  Moreover, gold was selling at a fairly low price, around $800/ounce.  

The market moves over time, however, and conditions change.  While I don't believe that we will see significant sustained deflation, I also don't believe that inflation is going to be nearly as high as most gold bulls believe.  

Gold is taking off right now and I see little reason for the exubberance.  Gold is now selling over $1050/ounce *IN SPITE* of the fact that a lot of the reasons behind a potential rise in gold prices have been undermined.  

Where is the Demand?

One of the reasons to be bullish on gold has been currency devaluation.  Here in the states, people tend to have an America-centric point of view and have postulated that rising inflation in the US would spark an increase in gold prices.  This may still happen, however, there's nothing to suggest at the current time that inflation is going to climb into double digit territory.  In fact, the US Treasury's forward outlook actually looks a bit better now than it did in say ... March.  

This is not to say that the US economy won't be sluggish and weighed down by government debt; but hyperinflation does not appear to be on the plate.  Rather, sluggish job growth will probably keep inflation fairly low in the near term.  The US debt load is sustainable; just not comfortable.  From a policy perspective, Americans need to find ways to lower the Federal debt, but from an investment perspective, I don't see it dramatically driving up the price of gold  

In truth, America might not even be that relevant to the discussion.  The spark behind the gold rally of late '08 was currency devaluation in Eastern Europe and Asia.  In particular, the Russian rouble collapsed with oil.  Now, we see the precise opposite situation with the Russian Central Bank having to buy $1.5 - $2 million worth of rouble to moderate price appreciation.  

With Asian and European currency devaluations seemingly becoming less likely at this point, what's the impetus for greater gold demand?  In fact, there's evidence to suggest that gold demand is trending downward significantly. 

Gold is Low-Beta; Gold Miners are More Vulnerable

Don't get me wrong, I'm not predicting a gold plunge.  Gold is a safety asset and people seem to be moving away from "safety assets" right now as the markets move forward.  Hence, it's possible that gold prices creep back downward to the $900 - $1000 range; for this reason, gold is "vulnerable".  Of course, it's also possible that gold continues to inch forward towards $1100 - $1200/ounce. Either way, you don't lose much and you don't gain much if you hold gold.  That's why gold is considered a "store of value" --- over a long period of time, it tends to maintain its value.

But what about the gold miners?  Gold miners are a bit riskier. Many of them have made minor profits, but are selling at ridiculous multiples.  As an example, over the past four years, Randgold's (GOLD) *HIGHEST* yearly profit was $74 million.  That was a little over $1 per ADR share at the time.  For FY '08, that profit was only about 61 cents per ADR share. For the first two quarters of FY '09, Randgold has produced a profit of 33 cents per diluted ADR shar.  Even if you assume that this might improve to an average of about $1 per share, that would still mean that GOLD has a P/E of about 75!

But wait there's more ... analyst estimates for FY '10 are very positive for GOLD and the most optimistic of analysts believes the company will make a profit of $2.10 per share --- which would still give GOLD a P/E ratio of about 35, in a commodity industry no less.  If you think they might have assets that justify that price ... well, their P/B ratio is also pretty high --- around 8. 

Maybe Randgold is an outlier.  Yamana (AUY), as an example, doesn't seem to be priced nearly as aggressively (I agree with TMFSinchiruna on that);  but there seem to be a lot of gold miners on extravagent runs right now. 

I don't know that I'd bet too heavily against anything gold-related; there are too many diehard gold bugs out there that drive up prices; but I can't see any great fundamental reason to be buying gold right now and most of the gold miners don't look very attractive either.

There Are Better Vehicles to Hedge Against Inflation

The bigger question to me isn't whether gold is "vulnerable" --- it is, but I might buy in anyway if I saw a reason.  I don't see much of a reason at this stage, however, because there are other commodities and other assets that will protect you from inflation better than gold and many of these commodities either have better fundamentals driving them or much better pricing than gold.  

Agricultural commodities like cotton, sugar, and grains seem like better investments to me than gold. Also, as I've been saying since early March, quality REITs are attractively priced.    The REITs are not as great values as they were earlier this year, but there's still some good quality out there at discount prices.  Or how about some inflation-protected bonds (WIP) or safer equities (e.g. CL, PG)?   And if you really want to play metals, there are metals with more attractive upside (even if higher beta) than gold.  Silver, for one, looks more undervalued than gold.  There's a good bull case for platinum and palladium, as well.  But what's going to drive up gold other than conspiracy theories?  

I can't see a good bullish case for gold right now.  If you want a "store of value", I wouldn't dissuade you from buying gold, but if you're buying in on the basis of making a great return, you might be looking in the wrong place.  Even if you want a long-term store of value, though, you might be better off putting your eggs into a different basket. 

Disclosure:  No position in gold or any gold related investments.