Gold: The Sure Thing That's Falling Like a Stone

This article has been adapted from our sister site across the pond, Fool UK.

During my lunch break, I sometimes go to the British Museum, which is just a Neolithic axe's throw away from the Fool's U.K. offices. And while I mainly go there to swap earnings for Egyptians and tickers for totem poles, my visits do occasionally yield insights into investing.

For example, tucked high up in Room 41 (Europe AD 300-1100) you'll find artifacts retrieved from the Sutton Hoo burial mound.

Believed to belong to an Anglo-Saxon king who was laid to rest in a ship shortly after AD 600, the haul includes everything from deteriorating cooking implements and disintegrating glassware to a rusting iron sword. Oh, and sparkling bright gold buckles, shoulder clasps, and jewelry.

The king is forgotten, his possessions are rusting away, and the Anglo-Saxon realm he ruled over was conquered by the Normans in AD 1066.

But the gold persists, perfect as the day it was fashioned more than 1,400 years ago.

Magic metal
Such is the stuff of gold bugs' dreams, as well as their investment thesis.

Gold can't be printed ad infinitum like paper money, and it won't fall down like a house or go bust like a stock. Durability and scarcity means gold has been used as a store of value for thousands of years -- and that hasn't changed just because we've invented electronic money.

While there's an element of truth in all this, some -- including me -- suspect it has been blown into a bubble in the past decade.

The price of an ounce of gold, around $250 in 2000, hit $1,400 in December. Appeals that this new high is well below the previous peak of $850 in 1980, provided you adjust for inflation, seem rather self-defeating, given how gold is supposed to protect us from spiraling prices -- it obviously did an appalling job of that in the two decades to 2000!

What's more, the relentless march upward of the gold price -- which began several years before the financial crisis -- seems suspiciously correlated with the invention of gold exchange-traded funds. These now dominate gold trading, yet they were only launched in 2003. Gold ETF holdings rival the reserves of all but the largest central bank hordes. It's hard not to suspect this sudden accessibility of gold as an asset has moved the price too far, too fast.

Miner mishaps
Hedge fund managers like John Paulson have been too busy making money from the gold boom to worry about such frippery. His massive bet on gold pretty much doubled his returns in 2010, swelling his assets under management by $8.4 billion.

Yet could the gold bears' day finally be nearing? The gold price fell to its lowest level in 10 weeks on Tuesday, after gold's worst monthly performance in more than a year. As I write, the price of an ounce of gold is down to $1,324.

The effect on some gold miners' share prices has been more marked. A few months ago, I heard veteran investor Jim Slater explain how he picks the good ones. But with the gold price falling, later arrivals to the gold rally might have done better to steer clear altogether.

Shares in $7 billion Randgold Resources  (Nasdaq: GOLD  ) are down 20% over the past three months, and U.K.-listed Centamin Egypt and Norseman Gold have slipped by similar amounts.

Since it costs money to dig gold up, regardless of the prevailing price of gold, a miner is effectively a geared bet on that gold price -- increases above the cost of production are all extra profit, but a falling price can equally devastate margins. Higher prices for oil and other commodities are also bad news for miners, since they increase the cost of production.

Not all miners have been hit. FTSE 250 member Petropavlovsk has held its value over the past three months, while Medusa Mining is up a healthy 22%. The latter switched from AIM to the main market in late October, though, which may partly explain its outperformance.

Half sold on gold
I wondered in September (I won't say presciently yet!) whether news that central banks were buying gold again marked the top. The gold price kept rising, but is now falling back to around that level.

Let's face it, though, a few months of gains or losses is just noise. True, there's speculation that growing risk appetite and the improving situation in Europe is making gold less attractive, but it's too early to call an end to its rally -- particularly while record low interest rates make it relatively cheap to own.

Curiously, even as gold loses its luster, I have slightly shifted my own view on the metal in the past six months or so -- not least after hearing Slater outline its virtues last September.

Part of me still sees gold as a Keynes' barbarous relic. But it's a relic I wouldn't mind having lurking in a dusty corner of my portfolio.

However, while it's impossible to say what the "right" price is for gold, my hunch is that buying in at the end of a decadelong rally where the price has advanced fivefold -- most recently against a backdrop of economic despair -- isn't likely to be conducive to grabbing a bargain.

I won't pretend to know where the gold price will be in a year's time. But when serious newspapers stop writing about gold every day -- and they will -- then perhaps that will be the time to start a mini hoard of my own.

More from Owain Bennallack:

Owain doesn't own shares of any company mentioned. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (7)

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 January 27, 2011, at 11:22 AM, summitclark wrote:

    It all depends on what your investment thesis on gold is? Has money printing debt monitization of QE ended? Is the world suddenly paying its bills? Have China, India, and the developing world stopped buying gold?

    If you can answer yes to any of these than please do sell.

    Look at it like this something goes in price from 2 to 10 in to years in a choppy upward fashion. Now it went to 14.3 and back down to 13.4. Do you panic and run for the hills?

    Let me know what the gold price is in 2 years? It will be higher.

  • Report this Comment On January 27, 2011, at 1:05 PM, FoolishAdvisor wrote:

    Using your logic that gold has appreciated too much over the past 11 years, then so has the DOW.

    http://stockcharts.com/charts/historical/djia19802000.html

    The DOW was only 759 in 1980 and now it is 12,000. Do you really think the 30 DOW companies have 15x more value than it did in 1980? Or are they inflated 1500%?

    I can tell you one thing, the market will be much lower 2 years from now. Gold will be much higher as more Euro nations default on their debt.

  • Report this Comment On January 28, 2011, at 2:00 PM, jordandrahota1 wrote:

    Gold -

    5-7 more times available then a much better metal (SILVER - utility, jewelry, currency) - hence more supply, that goes back to basic economics.

    You pay someone to dig it up,

    Pay someone to ship it- usually over seas (sure some in California, Nevada, etc.)

    Pay someone to dig a hole and build a fortress to protect it

    Pay someone to Gaurd it

    In the meanwhile every gold standard in the world has been abolished

    And then everyone blows the balloon to the point where it has no option but to EXPLODE -

    If you are interested in a precious metal that will have steady demand not just for inflation protection but more so for industry needs - Then choose SILVER- it is important to remember that silver is the best conductor of electricity in the world and is used in electronics daily- An industry that will continue to grow. Think about it...

    It's just my opinion

  • Report this Comment On January 31, 2011, at 12:19 PM, sumwit4u2 wrote:

    I am a novice. I do not pretend to know anything about the market except that I lost $30,000 (a BUNCH for me) when I tried my hand at managing a Deferred Comp Plan.

    I have however been putting some liquid assets in gold and silver. I havepretty much a 50-50 split in these. I got advice once from a stock broker friend who said that his outfit got out of a stock if/when i declined 20%. I have seen a greater decline than this since I got into metals, but know that they suffer wild swings. Any advice for a fellow fool?

  • Report this Comment On May 11, 2011, at 10:01 AM, franknee wrote:

    gold was $22 the troy oz in 1929. from 1936 until 1973 it was $35. now it's about $1350. up 35 times.

    it no intrinsic value, except as jewelery. yet it's costly to mine and limited as to supply. it is the only storehouse of value. it could go down to maybe 900, i think it will go higher to say $2500 sometime later this year. and if Obama isn't able to save the USA from insolvency, the whole world including China will look for a dictator to lead us from chaos.

    then only gold will be worth a meal and a drink. it well be the only storehouse except farmland>>it will be 10,000 years ago, when mankind pulled it's own ploys and dug it's own roots. then people with gold will eat>>everyone else will starve.

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