It took me a good year and a half to get back on track after the beating I took during the internet implosion of 2000. That was an extremely painful year, and I was in no rush to donate more money to Wall Street. I tried some of the same old stuff from 2000 to early 2002 with little success. In late 2002, I discovered Adam Hamilton and the world of commodity stock investing.
Ever since I’ve been in high tech, I’ve seen firsthand how tons of money is poured into all things internet. Engineers with Power Point presentations had raised millions of dollars in venture capital money, while capital-intensive areas like mining were ignored. The recovery of an investment in the Internet was infinitely shorter than an investment in mining. Mining companies had to find deposits, extract them, and then sell them. There were environmental and political issues to overcome, as well as potential labor issues. With virtually no mining investment, it made sense that commodity prices would be through the roof.
As I learned more about commodities, I understood why most of Main Street avoided investing in this area. Investing in mining companies has too many moving parts. Not only are you concerned with the fundamentals of the company, but the direction of the product itself plays a big factor. Gold stocks rarely go up if gold itself has a downward trend. There is also political risk. Gold is found in all parts of the world and sometimes governments play by their own rules. Every once in a while, a non-mining friendly government takes over a mine after companies have invested millions in development. Unfortunately, there are many more factors that affect the price of gold. In Adam Hamilton’s latest essay, he lists 10 factors that affect the price of gold.
Many people believe that we are in the second phase of a secular bull market in gold. If that’s true, investment demand will trump all other drivers; That happens to be the easiest of factors to understand. Basic economics states that when demand exceeds supply, prices rise. Rising prices provide an incentive for producers to increase production. However, as already mentioned, it takes more than a Power Point presentation to produce Gold. In other words, prices will continue to rise until demand is met.
The question is what will cause investment demand to rise too much. In November 2004, GLD, a gold exchange-traded fund (ETF), was listed on the New York Stock Exchange. For the first time, investors could buy gold as easily as buy stocks. No further trips to the local coin dealer were required. No more worries about storage. Just click a few buttons and you will own gold. GLD has become one of the fastest growing ETFs in the United States.
GLD has not only provided opportunities for individuals, but also for many institutions, such as pension funds, which have been prohibited from directly owning gold. For diversification purposes, it is quite useful to own asset classes that increase in value while others do not. It is well known that commodities do exactly that: they are negatively correlated with stocks. So GLD becomes a great way for institutions to further diversify their assets. A silver ETF was listed in May 2006 and the introduction of a platinum ETF in 2007 is under discussion.
That’s all well and good, but it’s demand from Asia that will drive gold to all-time highs. Asian cultures have a strong affinity for gold. One’s personal wealth is traditionally determined by the amount of gold one owns. Indian brides receive gold dowries often in the form of gold jewelry or gold coins. Indian families store the extra income from the harvest each year in gold jewelry. It is truly a fabric of your life.
China is on the verge of becoming the world’s next superpower. As Asian investors get richer, their gold ownership will increase. There are literally billions of people in China. It is true that many will not achieve the standard of living enjoyed by the US, but the demand created by hundreds of millions of Asians buying small amounts of gold will be unprecedented.
Yes, that demand will take some time to materialize, but gold investors are quite satisfied today. In 2006, GLD outperformed the S&P 500, 22.5% vs. 13.6%. My vehicle of choice Central Fund of Canada (CEF) has a 55/45 mix of physical gold and silver that outperformed both, 37.2%.
I used to try to convince my friends to buy gold by talking about inflation, the falling dollar and geopolitics. Now I’m just talking about supply and demand.
By the way, GLD was recently listed on the Singapore Stock Exchange.
