Looking at Gold for 2011

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You know it’s time to discuss gold when ads are telling us to empty jewellery boxes, safety deposit boxes, and sock drawers and turn those tired old watches, rings, and necklaces into real hard cash.

But what has turned this sudden craze into a booming industry for late-night television producers? And is it really time to trade a physical asset into liquid cash? Spot gold has risen from $430 per troy ounce to more than $1,250 in the past five years, a pretty impressive return for any asset class. So it’s not too surprising that we are being bombarded with seductive ads to part with our personal gold assets. But as an asset class, perhaps we should be buying, not selling, this shiny commodity.

Global stock and bond markets continue to gyrate and, given the prospect of a double-dip recession, gold investments continue to shine for market-savvy investors. As an asset class, gold reacts differently to economic forces such as interest rates, inflation, and political instability. It makes sense for investors to consider adding it to their portfolios.

Gold bugs and stock market pessimists tout the idea that fiat or paper money is a shell game built on a house of paper promises. It has no value except as legal tender and its strength as a store of value relies on the continuing belief by holders that the paper itself will maintain a stated value.

Central banks around the world continue to maintain low interest rates and print money with seemingly reckless abandon to prop up the corporate and government sectors of society. When Europe unified its currency a decade ago, it was heralded as a welcome alternative to the U.S. dollar. However, both currencies are now under significant pressure that may cause a stampede back to gold.

Global Debt

{advertisement} The U.S. government debt currently stands at more than $13 trillion, increasing at the rate of $1 million per minute. If you want to be truly shocked, the Economist magazine has created a global public debt clock at www.buttonwood.economist.com. At the time of writing this article, the debt clock stands at $39.6 trillion. If the confidence dam ever breaks and individuals lose faith in fiat money, then canned goods, shotguns, and gold may once again surface as investments of choice.

If we eliminate canned goods and shotguns, that leaves gold. In many countries, small investors can walk into coin and jewellery shops and buy coins, small bars, and jewellery for personal gain, safety, and financial insurance. It’s almost embedded in the human psyche that when all else fails, gold will hold its value as a store of wealth. It has been the safe haven asset during times of economic strife, inflation, stagflation, and deflation.

For gold bug enthusiasts and general investors, the question of maximizing wealth creation through gold exposure means choosing the best vehicle. Should an investor choose gold bullion, gold stocks, or gold derivatives? It’s not an easy answer at the best of times, but fortunately the market for gold vehicles has increased exponentially in the past two decades.

Gold bullion (coins and bars) trades on a spot (the current price per troy ounce) and futures (the price of gold at a predetermined future delivery date) basis almost continuously around the world. Major trading centres are New York, London, Hong Kong, Sydney, Tokyo, and Dubai. Gold mining companies that produce thousands or millions of ounces use these markets to lock in profits; speculators prefer to use the advantages of leverage when investing in the futures market by placing bets on gold’s future price.

Gold Stocks

Stock market players who want exposure to gold have several options. The TMX, which owns and operates Canada’s two major stock exchanges, provides detailed information for investors. Its website, www.tmxmoney.com, lists the component companies in the TSX/S&P Global Gold Index. Investors can research and invest in any of these companies or purchase the underlying exchange traded index (ETF, symbol XGD).

Aggressive investors can purchase the Horizon Beta Pro Global Gold Bull or Bear ETF (symbol HGU and HGD). These derivative ETFs are designed to mimic twice the daily performance of the underlying index, less expenses. For the speculative investor, the TSX venture exchange currently lists 1,144 mining stocks, but not all of them may be gold-related. Caveat emptor, though, because this exchange provides an almost unlimited supply of junior companies trying to find the next bonanza. Most disappear off the financial pages in just a few years.

Mutual fund investors can choose from a plethora of gold and resource funds. The web site www.morningstar.ca reviews and rates the absolute and relative performance of resource-based funds and is a useful tool for investors who prefer a more diversified approach with professional management. But it doesn’t end with stocks and funds.

The addition of derivative investment vehicles allows investors to own gold indirectly on leveraged and unleveraged investments. The SPDR Gold Shares is an exchange-traded gold trust with each share representing 1/10th of an ounce of gold. They trade in U.S. dollars on the NYSE under the symbol GLD. In addition, for the sophisticated investor, SPDR Gold Trusts also trade options on the underlying units, which means an investor can bet or hedge against the future price of the GLD!

Investors who wish to own units of a Canadian bullion fund have several choices. Central Gold Trust (symbol GTU.UN or GTU on the NYSE) provides a pure play on gold bullion similar to the SPDR Gold Trust; its units are bought and sold through investment advisors or online brokerage firms (see www.gold-trust.com). The Claymore Gold Bullion ETF (symbol CGL) provides investors with the opportunity to own a divided interest in gold bullion hedged back into Canadian Dollars (see www.claymoreinvestments.ca).

Alternatively, Mulvihill Capital Management Inc. manages the Gold Participation and Income Fund (symbol GPF.UN). This fund seeks to invest up to 50 per cent in the SPDR Gold Trust and up to 75 per cent in the component shares of the S&P/TSX Global Gold Index. The fund targets an annualized income return of 6.5 per cent by engaging in option writing strategies.

Lastly, to monitor the latest quotes, updates, and research, go to www.kitco.com; it tracks spot and future prices of gold, silver, and other precious metals and provides links to articles on the latest trends. Novice investors, however, should be cautioned against falling into the trap of becoming gold bug enthusiasts. Five asset classes need to be considered when constructing investment portfolios: stocks, bonds, real estate, cash, and commodities. Reading gold newsletters can lead some investors to forego the other four categories and concentrate all of their holdings in gold, shotguns, and canned goods.