Gold:
Today, the gold market is a broad one, but still a relatively small one. The interesting aspect of a broad market is that it is (i) global, and (ii) diverse, with many ways to invest. There are many gold markets, priced in cash (spot) or forward prices, and many ways to buy gold and other precious metals, including bullion bars or coins and gold-related equities. Of all the commodity markets, the gold market is probably the largest and most free market in the world. In terms of total capitalization, relative to say oil or pharmaceuticals, the gold equity market is tiny. Gold is an interesting market for traders who do not get caught up in the hype.
To millions of people in the world, the gold metal as stored bullion (bars or coins) or jewellery is the finest form of tangible wealth. It is a symbol of security that protects the individual against a number of risks, including loss of wealth through taxes and inflation, nationalization or confiscation of real property or paper currency (e.g., Germany, France, Italy, Russia, Mexico), and worldwide threats of war and revolution.
Gold is distributed widely over the earth, and gold mining is pursued in most countries, but the leaders are South Africa, U.S., Russia, Canada, and Australia. In a year, there are less than 3,000 tons produced. All the gold mined in history, in fact, would fit in a cube 60 feet across.
Gold bullion coins range in size from as small as 1/25th of an ounce up to the full kilogram (32.15 troy ounces) Australian Nugget. By far the most popular is the 1-troy ounce size, which accounts for most of all bullion gold traded. See troy weight at this link.
The purity of gold is measured in carats (karats in U.S. and Germany). Traditionally, bullion coins, such as U.S. Eagles and South African Krugerrands are 90% to 91.7% pure (i.e., 22 carat). The addition of another metal (copper and/or silver) as alloy makes these coins stand up to wear better than pure gold (24 carat), which is soft. Many modern bullion coins, such as the Canadian Maple Leaf, are pure gold, because they are not likely to ever be used as circulated 'money.' The key point, however, is that Krugerrands or Eagles, just like Maple Leafs, contain exactly one ounce of gold.
Bullion prices result from shifts in foreign currency markets, changes in industrial/commercial demand plus economic factors such as inflation, and so forth. Goldminer stock prices trade off gold bullion prices as well as the underlying corporate fundamentals (i.e., revenue and earnings growth plus increase in asset value, etc).
Long term gold investors enjoy the comfort of owning a precious metal that has ever-rising potential value. But the price of gold does not always rise, and there is no income from holding bullion, so, over time, quality gold stocks have been the better investment, with fewer risks and fluctuations.
Americans could first trade gold bullion in January 1975. Within a few years, the price rose from US$197.50 to over US$870 per ounce. That was a huge gain; far above what the equity or fixed income markets would have returned, on average, during that five-year period.
As the great bull market ended in gold at the end of the 1970s, the buy-and-hold bullion investor could have tripled his money. Then, as had happened in earlier gold price cycles, the price fell sharply, so the investor should have been out, and the trader should have been net short.
If you were an astute (or lucky) market timer in bullion who bought at the cycle lows and sold at the cycle highs, you would have stayed a step ahead of inflation. But, even in the inflationary 1970s, in order to profit nicely, bullion traders had to catch the bull moves.
By selling short in January 1975 at $197, covering positions in August 1976 at $104, holding until January 1977 to sell at $174; buying in 1978 to benefit from the surge from about $200 to $800; selling short and covering at around $500, it's safe to say the bullion trader made a lot of money.
But, then for the next 20 years, following the 1980-1981 top, gold prices dropped to about $225 for the bullion, so long-term bullish gold investors were badly hurt. Losses applied to both the bullion and the goldminer stocks.
The best profits with gold in the 1970s, and subsequently, came from speculating in the goldminer shares, i.e., buying low and selling high; selling short and buying back at the next low; and so on. In those inflationary years, a trader could have counted on steady income from dividends of over 10% a year plus the capital growth.
With compounding, that meant average annual rates of return, including capital gains, of 25% to 50%. Over the last six years of the 1970s, a gold equities trader who was both smart and lucky might have made 30 in and out trades and increased his capital 25 times.
But, with the end of the high inflation 1970s, it became difficult to make suitable investment returns in either gold bullion or shares. But, at that time the new equity options market became a useful one to gold traders. Then in the 1980s, market-listed gold holding companies, mutual funds and bank-issued gold certificates came along, and in the late-1990s the gold exchange-traded funds that tracked gold stock indexes came into play.
So, the gold market broadened in recent years, which, through the disinflationary 1980s and 1990s (i.e., a 21-year secular bear phase for gold) sustained the interest of gold traders. Otherwise that interest would have waned.
From about 2001, however, most expert gold traders believe that a secular bull phase has started in the gold market, although without a return to relatively high levels of inflation, the price increases for gold bullion and stocks may be muted.
Choices for trading in gold
If you wish to trade in the gold market, here are the obvious choices:
(1) Companies listed on major stock exchanges such as NYSE and Amex plus the Toronto and London exchanges. The more speculative issues trade on the venture markets.
The listings range from major to secondary gold producers and gold royalty holders, to gold exploration companies that have track records as well as many that don't, to the very junior so-called exploration companies that are essentially penny stock promotions.
The most senior of these goldminer corporations, like Newmont, Barrick and Placer, provide full, detailed reports to stockholders and their shares can be bought and sold easily. Most are large and relatively stable corporations with mineral assets that include silver and copper. But the name of the game is still gold.
(2) Exchange traded holding companies, which are also known as closed-end investment funds.
ASA Ltd (NYSE: ASA) is a closed-end investment company organized in 1958 to provide investors a vehicle to invest in a portfolio consisting primarily of stocks of companies conducting, mostly, gold mining and related activities in South Africa. The Company is permitted to invest up to 20% of the value of its assets outside South Africa and may also invest up to 25% of the value of its assets in gold bullion or gold certificates. Some 70% of its assets are in South African gold mining shares.
Another is Anglo-American PLC (NDQ: AAUK), the largest mining finance firm and the number one producer of both gold and diamonds.
With exchange-traded closed-end holding companies, you are buying the equivalent of shares in a mutual fund.
(3) Gold share index Exchange Traded Funds (ETF). The S&P/TSX Capped Gold Fund (TSX: XGD) is an ETF that has traded since March 2001 on the Toronto Exchange.
Some of you have asked about mid-tier gold producers. To find a good list (name/TSX ticker/index weighting), the Barclays BGI iShares ETF contains some good ones. Most of the 17 gold stocks that (November 4, 2005) make up the Canadian gold stock index also trade in the U.S.:
Here is the table:
This is a Capped Fund where the MER is capped at 55 basis points, which means the annual cost for admin is 0.55 pct. That compares very favorably to most of the goldminer mutual funds. The trick to earning trading profits is to make timely decisions to buy and sell the index.
Some of you are not able to buy this security through your broker, and you have asked me for the names of the individual gold stocks I recommend. That's not really fair, so what I have done is provide this table with both U.S. and TSX ticker symbols. I also have opined that the senior producers are somewhat expensive now, and that, if this gold rally is to continue, the best bets are in the mid-tier group.
That means dropping the first four from the list (Barrick, Placer, Goldcorp and Glamis) and choosing from the rest. Except there are a few foreign-controlled goldminers operating in Venezuela that I would not touch, for the reasons I have written up (Chavez). Prices have been reacting to the political risks there after there was a major fall-out on Sept. 20.
The gold players in Venezuela are:
Bolivar Gold: TSX: BGC
Crystallex: TSX and AMEX: KRY
Gold Reserve: AMEX: GRZ
I also believe that silver miner Hecla Mining (NYSE: HL) is there as well.
If these names are new (they are after all a group of small caps), then go to the Yahoo Finance industry (Gold) list, and bring up the details on revenues, etc. Then review the charts to see the ones that seem to trade in sync with the rise and fall in the gold bullion.
(4) Gold bullion ETF. The NYSE recently started to trade gold bullion as a security in the form of an Exchange Traded Fund, under the ticker symbol NYSE: GLD.
According to Yahoo Finance, the streetTRACKS Gold Trust (NYSE: GLD) is an investment trust whose shares strive to reflect the performance of the price of gold bullion, less expenses of the Trust. The Trust holds gold, and is expected to issue baskets in exchange for deposits of gold, and to distribute gold in connection with redemptions of baskets. The gold held by the trust will only be sold on an as-needed basis to pay trust expenses, in the event the Trust terminates and liquidates its assets, or as otherwise required by law or regulation. The Trust is not managed like an active investment vehicle, and it's not registered as an investment company under the Investment Company Act of 1940.
In addition to GLD, there are three other well-known bullion ETFs:
· Gold Bullion Securities (LSE: GBS) is an open-end gold fund that has traded on the London Stock Exchange since March 31, 2004,
· Gold Bullion Securities (ASX: GOLD) is the same GBS open-end gold fund that trades on the Australian Stock Exchange, and
· Central Fund of Canada (TSX: CEF.NV.A) (AMEX: CEF) is a Gold and Silver Bullion Share Investment (At least 90% of Central's assets are Gold and Silver at all times.) that invests in combined gold and silver bullion holdings at a ratio of 1:50 by weight, which is about 50/50 by USD value. The Central Fund is the oldest bullion ETF, having been founded in 1961, but has evolved a lot over the years.
(5) Put/Call options. There are equity options that give you the right to buy goldminer shares at a set price before a set date. They are securities that involve leverage. If you guess right, you can do well; but unless you use put/call options as part of a trading strategy, I would definitely choose a different instrument to invest in the gold market.
Yahoo Finance has an excellent info service for options traders. For example, here is the link to the Newmont options.
The Montreal Exchange offers options trading in the XGD iUnits S&P/TSX Capped Gold Index Fund.
(6) Gold futures contracts. These give the speculator the biggest bang for the buck. Similar to contracts for commodities, they can be handled by most brokers and are actively traded on the New York Commodity Exchange (Comex) and the International Monetary Market in Chicago.
Other precious metals charts are available at TradingCharts.com as well:
Gold NY Mini (YG, CBOT)
Palladium (PA, NYMEX)
Platinum (PL, NYMEX)
Silver NY Mini (YI, CBOT)
Silver, 5000 oz (SI, COMEX)
In bull markets, trading in gold futures can be very profitable. A 5-point move is common. With a little patience, nimble traders can pick up a short-term 10-point move, but a little practical advice is in order for the novice:
(i) Never commit any of your money to a high risk area of trading unless you have comfort in doing so. Most brokers who trade futures contracts ask for a minimum balance of $10,000, which is a lot for an owner of relatively small capital, given the need to properly diversify the portfolio. If this makes you uncomfortable, try another market.
(ii) If you have $100,000 in total, use no more than $10,000, i.e., 10 percent of the total, for futures, and preferably no more than 5 percent, which means traders ought to have at least $200,000 in their portfolio. Put the balance in diversified equity funds.
(iii) Never give discretionary powers to anyone.
(iv) Limit the possible trading loss to 14% of the total account.
(v) Paper trade for at least one month before you commit any dollars. Make decisions, calculate margins, set stop-loss prices, etc.
(vi) Read all commodity trading firm bulletins and reports you can find, including reports on all the precious metals.
TradingCharts.com provides a good service for all the precious metal futures contracts, including charts and news.
Gold charts and gold-related news.
Silver charts and silver-related news:
Platinum charts and platinum-related news:
Palladium charts and palladium "related news:
(vi) Use charts to check daily and weekly price movements and trends. In addition to TradingCharts.com, I also frequently use the ones at StockCharts.com and Investertech.com.
(7) Gold coins. These are non-numismatic coins, meaning they have been minted only for the collectibles market. The major forms are South African Krugerrands, Canadian Maple Leafs, U.S. Medallions, Mexican pesos, and Austrian coronas.
Gold coins are minted in different sizes according to the gold content: 1 oz., 1/2 oz., 1/4 oz. and 1/10 oz. You can check the daily value of your holdings in the press or from radio/TV reports.
Because of coinage and distribution costs, the coins sell at a 5% to 8% premium over gold. Local sales taxes can add another 8%. If you wish to trade coins, do your homework before you buy, and calculate how much premium you are paying.
Some investors like to trade in gold coins and in gems because they can do so in secrecy like bearer bonds. However, with Know Your Client legislation and industry regulations growing rapidly around the world since the events of 9-11-01, unless you plan to buy these on the street and keep them in a safety deposit box, your broker or financial institution will have to keep records that are accessible to the authorities.
(8) Gold certificates. These are certificates that represent ownership of a specific portion of bullion stored in a bank like ScotiaBank, which is a leading Canadian bank that operates around the world.
The gold certificate sales price includes fees for insurance and storage plus commissions, which, depending on quantity, run from 1% to 3%. The certificates are not negotiable or assignable, so they must be sold back to the dealer.
(9) There is also a new type of "gold exchange" that facilitates instalment buying of gold bullion with the goal of building substantial holdings. The bullion you buy on the instalment plan is stored abroad or in a state where there are no taxes. There have been a number of failed ventures in this area, so due diligence is an absolute requirement if you are considering trading gold in this way.
There are two types of bullion instalment contracts, which mimic investing in mutual funds:
(i) Unit price averaging, which is where the investor agrees to buy a fixed amount of gold regularly, paying less when the price is low and more when high.
(ii) Cost averaging, which is investing a fixed sum at periodic intervals and buying more when the price is low, less when high.
There is also something called e-gold, which I haven't bothered to follow up due to previous skepticism.
Summary
In my career, I had a range of experience in the gold market, from trading, research, visiting mining properties (including being accidentally caught in an underground dynamite blast in a mine near the arctic circle), attending gold conferences, financing gold exploration, and so on. It all started as an auditor for KPMG where on Bay Street Toronto in 1967-68, I was assigned to examine the books of many of the famous stock promoters and mine finders.
I learned a long time ago that there is some truth to the saying that a gold mine is a hole in the ground with a liar on top. For sure there are a lot of liars in the gold business, but many are unbelievably hard working people too, as is the case in all capital markets.
Actually, it's more a case that many gold-related "investments" are not really investments, but speculations, and, with all the liars about, many of those so-called opportunities are beyond generally acceptable limits of credulity.
There are many ways to trade in gold, and even if many are not, most situations are legit. Like any trading market, there are nuances to learn, and due diligence required.
Posted by Bill Cara at February 9, 2005 9:10 AM
