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Gold’s Lost Luster

By Roger Conrad on December 28, 2012

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Put aside the alarmist rhetoric that says gold is an investor’s only recourse amid today’s uncertainty. Regardless of its merits as a hedge, the yellow metal is no all-purpose substitute for a diversified portfolio.

However, it’s sometimes difficult to impart reason when fear holds sway. Earlier this year, I spoke on an investment cruise from which most attendees seemed to take away one message: Gold was headed to $6,000 an ounce, and it was absolutely imperative for investors to load up immediately, preferably by selling everything else.

At least one speaker warned investors away from gold stocks and even the SPDR Gold Trust (NYSE: GLD), the premier exchange traded fund for the yellow metal. Only the hard metal would do, stored in a location that would ensure privacy.

As it turned out, there was no such urgency to buy gold in 2012. In fact, whenever risks to the global economy seemed to increase—such as in May with the apparent slowdown of Chinese growth—the US dollar and US Treasury bonds were the main beneficiaries. Gold sold off sharply.

For the record, gold is far from the worst investment you could have made this year. As of this writing, the metal’s price is still ahead by about 6 percent for 2012.

Moreover, the metal’s modest gains trounced the losses rolled up by most gold stocks. With just a couple of days to go in 2012, for example, Barrick Resources (TSX: ABX, NYSE: ABX) was more than 20 percent underwater for the year. Worries about a sudden austerity crisis triggered by the US federal government have only spurred more downside; Barrick’s performance was more than 35 percentage points worse than the showing of the blue chip S&P 500.

Nonetheless, it’s clear that the sentiment on the cruise was something of a high water mark for gold. Despite what’s been unprecedented uncertainty for the markets in general, gold has been a somewhat disappointing investment for 2012.

Viewed one way, this year’s performance marks a sharp deceleration from the gains realized over the past 10 years, as the yellow metal has climbed from a few hundred dollars to a range of between $1,500 and $1,800 an ounce.

The Fearmongering Factor

I’ve always been deeply suspicious of economic arguments that claim anything is inevitable. Perhaps more than any other market, gold seems to attract investors anxious to bet real money on possibilities others would final laughable, such as individual states opting successfully to mint their own currency. Wise investors learn to spot fearmongering and ignore it.

It is indisputable, however, that in today’s dollars gold’s 1980 high of $800 an ounce is equivalent to better than $3,000. Moreover, easy money such as we’ve seen in unprecedented doses since autumn 2008 has always historically helped gold rally. And although the markets continue to vote no to the proposition, it’s always possible the US dollar will eventually lose its primacy.

Unlike every other metal and resource, gold is almost never actually consumed. Rather, the vast majority of everything produced in the history of the world is still in someone’s possession.

Traditional supply/demand metrics are pointless when it comes to determining gold prices. Rather, it’s all about demand. The more of the yellow metal that global investors want, the higher prices go. And when demand does cool, so do prices.

Since the end of 2007, gold prices have dramatically outperformed the S&P 500 index, more than doubling investments versus a modest 8 percent total return (including dividends) for the blue chip index. The correlation between up moves in the S&P 500 and increases in the SPDR Gold ETF, however, is surprisingly tight.

Now get ready for the big surprise. The reason is for the past five years both the price of gold and the S&P 500 have been rising when prospects for global growth appear to improve. Meanwhile, both the price of gold and S&P 500 have tended to decline when prospects for growth have appeared to diminish.

That’s basically the same dynamic other investment sectors have followed, including dividend-paying stocks. The only exceptions have been US Treasury bonds and the US dollar, which have rallied when prospects for growth have darkened and dropped when the economy has seemed to improve.

Gold was far from the worst investment in 2008, managing a return of about 4.9 percent while most markets melted down. But it’s otherwise performed like anything but a disaster hedge, running up its biggest gains when the overall economic picture has been on the mend. And it did lose money in the second half of 2008, just like everything else did except of course Treasury bonds.

What does this say about gold’s long-run prospects? Simply that the metal will perform a lot better when global growth finally does come roaring back. After the massive gains of recent years, the metal is unlikely to do a whole lot until that happens.

We continue to hold gold in the Personal Finance Portfolios in the form of gold stocks and gold mutual funds. We’ll likely add more as the economy does get back on its feet in the coming months.

But with sudden austerity nearly certain in 2013, the better place to be right now is in stocks of high-quality, low-debt companies with reliable revenue from a wide range of countries. Dividends paid in Canadian or Australian dollars gain ground for every step the US dollar loses. So do stock prices of companies hailing from those countries.

Gold’s stellar performance during the inflationary 1970s means it will be an ideal investment if inflationary pressures do blow the doors off in coming years. That in my view is a very real possibility. And still priced at barely half its all-time, inflation-adjusted highs, gold is hardly expensive, even after the robust gains of the past decade plus.

I remain an advocate of holding gold. But as this year’s events have shown once again, the yellow metal alone is no substitute for a diversified portfolio. And those who do buy in must be patient. Gold’s gains over the years have been explosive to say the least. But they’ve rarely if ever been either steady or predictable.

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  1. avatar
    John Malett Reply December 29, 2012 at 2:10 PM EDT

    anxious to hear about the dividend champions