All That Glitters Isn't Gold

Talk about having your ducks aligned, the wind at your back, an engine firing on all cylinders, and every other cliche that implies the market gods are smiling favorable upon you. I'm talking about gold, of course. The metal has been on a tear for the past six years, tripling in price to trade above $1,150/ounce within the past week -- a record high (at least in nominal dollars). It's a secular run in full force, having begun long before the collapse in housing prices and the even more dramatic collapse in financial stocks.

Bulls abound
The run is unlikely to end anytime soon, at least according to the gold pundits. The more reserved among them inform us that $1,300 an ounce is around the corner, while the more enthusiastic ones tell us $5,000 per ounce is within the realm of possibility. A few hundred dollars in price is nothing when an additional 400% on the upside awaits.  

It's easy to understand why so many of us have been bitten by the gold bug when the pro-gold argument is spread out before us:

• Heightened risk aversion among investors.
• An overall rise in commodity prices.
• Short-term interest rates close to zero (and negative in real terms).
• Massive government fiscal deficits. (e.g., during the fiscal year that ended Sept. 30, the Treasury reported a record deficit of $1.4 trillion).
• Anxiety over inflation.
• A depressed dollar vis-a-vis the euro.
• Rapid money supply growth (e.g., from September 2008 to September 2009, the Federal Reserve pumped an unprecedented $2 trillion into the financial system by buying Treasury bonds and other assets from banks.).
• Reports of dwindling gold supplies.

Getting in the game
Bullion and coins are preferred option for many getting in the game, but they are encumbered with transportation, storage, and insurance costs, while gold coins demand a numismatic mark up. Gold ETFs offer an indirect direct option to track gold prices, but you don't possess the actual metal.

Indirect ownership -- gold stocks -- is another option more investors have warmed to, but it's not a gold overlay. Gold mining is a business incurring its own mark ups, influenced by many factors, including the grade of the deposit, the depth of the deposit, proximity to refining capacity, energy and labors the cost, and all the capital costs associated with any mining operation. The miners, therefore, don't track gold directly.

That said, gold producers are price takers (gold production only adds 1% to 2% a year) so gold prices hold sway over gold-mining fortunes. And with gold currently exceeding $1,150 per ounce, these fortunes have been well driven this year. In fact, when compared to the SPDR Gold Trust EFT (NYSE:GLD), as an example of a direct gold investment proxy, the gold miners have been driven exceedingly well, out pacing the actual metal in many instances this year.  

Source: Capital IQ and Yahoo! Finance.

Caveat emptor , especially now
Gold's upside potential remains and an advance doesn't automatically trigger a retreat. I have concerns, nonetheless, not the least of which are the reasons offered for gold's advance, which have been thoroughly parsed, thoroughly explicated, and thoroughly incorporated into today's price.

I also see parallels in the gold market and the Internet market of a decade ago and the housing market of a few years ago -- based on the extensive marketing of these investments to retail investors. Those of us a little longer in the tooth remember the pitches promoting the merits of online trading and Internet investing. Newer investors might remember the residential real estate pitches: Flip those putatively safe investments for instant profits!

Remember how those bullish runs ended?

I see a similar push in gold. AM radio, the business section of your local newspaper, and cable business outlets offer a superfluity of gold commercials directed at the retail investor, which I interpret as more people aligning on the same side of the gold market. When investors and speculators align, ducks tend to run askew, headwinds form, engines start misfiring, and metaphors start falling apart. These above-average performing gold miners are more likely to turn into below-average performers when the eventual fallout comes.