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Gold Delivers a Gut Check

So much has changed, but nothing is different. That paradox describes the past several weeks to a T. The canyon of disconnect between late winter's gold fever and the exodus of early spring makes about as much sense as my opening line. The price action can be easily understood, but investor sentiment is a different beast entirely.

Like a cruel physics experiment, first-time investors who clamored for gold as the price soared through $1,000 have been flushed out of the market with an equal but opposite force. As the metal has retreated to $850, and especially in recent days, I have witnessed an erosion of confidence even among seasoned traders of precious metals. This correction is a deep one, to be sure, but it provides a critical gut check. If you've been shaken out of gold in recent weeks, then gold may not be for you.

In a long-term secular bull market for gold, corrections are par for the course. In fact, the correction of mid-2006 was considerably more severe than the present episode, and provided me with a gut check I'll never forget. Gold has fallen 16% from its peak this time around, compared with 21% from peak to trough in 2006. Silver in 2006 fell from $15 to under $10, for a loss of 33%. When compared to 2006, the current drop of around 20% to near $17 causes this Fool not one troy ounce of worry.

I'll admit my confidence was shaken in 2006, and I made the cardinal mistake of selling some positions into weakness. I regret those sales to this day, but that experience is what has permitted me to remain calm and focused throughout the present correction.

Tuning out the static
Long-term investors in gold and silver are no strangers to being on the flip side of conventional wisdom. A daily chorus of articles and commentaries from media outlets has begun to declare a reversal in the U.S. dollar, promoting a move away from precious metals, commodities, and related investments. As much as I wish it could be true, as the U.S. economy really needs a dollar reversal, I have seen no evidence of a fundamental shift. To the contrary, the Federal Reserve has demonstrated a clear bias toward economic stimulus and the normalization of credit markets while turning a blind eye to the dollar.

In markets as volatile as gold and silver, I consider it folly to try to time short-term movements. I maintain flexible long-term price targets, which I establish according to ongoing analysis of the underlying fundamentals, and as far as I'm concerned everything else is pure noise. As long as that fundamental picture remains unaltered, I stand my ground like Tom Petty.

While trimming some profits on each march higher and pressing positions on major dips can indeed tweak results nicely, the core positions remain intact because gold can make tremendous moves when you least expect it. With the popular attention gold has attracted of late, these swings are bound to become ever more frequent and more severe as the gold bull progresses. For the far-sighted Fool with the stomach for some serious volatility, opportunities abound.

My pain is your gain
Thanks to the depth of this correction, gold and silver bullion have retreated to prices not seen since January. Since mining stocks are effectively leveraged to the price of the metals, miners have fallen even more dramatically. So where to invest in gold and silver? Savvy Fools will decide for themselves an appropriate level of exposure to precious metals, and then spread that allocation judiciously among bullion proxies, major miners, intermediates, and perhaps a producing junior or two.

The Central Fund of Canada (AMEX: CEF  ) is a well-respected and time-tested proxy for bullion that holds roughly equal values of gold and silver bullion in its insured, audited vaults. A very simple, two-pronged approach to precious metals exposure could be achieved utilizing Central Fund for gold and silver bullion and the Market Vectors Gold Miners ETF (AMEX: GDX  ) for mining shares.

Among the majors, unhedged Newmont (NYSE: NEM  ) looks attractive after posting excellent results recently into a sharply declining gold price. Freeport-McMoRan (NYSE: FCX  ) shares have proven resilient on the strength of copper exposure, yet still sport a glimmering forward 2008 P/E of only 10.2.

Intermediate miner Kinross Gold (NYSE: KGC  ) earns four out of five stars from Motley Fool CAPS players despite having lost more than 20% in recent weeks. If it's juniors you seek, look for budding producers in politically stable areas that have seen the greatest percentage declines since the correction began, and you are sure to find some attractive candidates.

Most importantly, though, give yourself a gut check. Gold is not for every Fool.

The CAPS community is a free service with access to collective ideas about individual investment options. Join 100,000 other investors by registering with CAPS here and posting your own online portfolio today.

Fool contributor Christopher Barker captains yachts and writes about stocks. He can also be found acting Foolishly within the CAPS community under the username Sinchiruna. He owns shares of Freeport-McMoRan, Kinross Gold, and the Central Fund of Canada. The Motley Fool has a gilded disclosure policy.

Read/Post Comments (2) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 27, 2008, at 10:55 AM, GObserver wrote:

    Gold might not be for every Fool, yet utterly foolish not to hold it. Go figure.

  • Report this Comment On October 24, 2008, at 1:37 PM, edshull wrote:

    With stocks slipping further and further, gold just makes more sense. It was a little scary at first, I'm new to precious metal investing. But I found Monex to be pretty helpful. So far I have taken positions in gold and palladium.

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