Monday, January 16, 2012

Gold Still Warrants a Place in One's Portfolio

During my endorsement of gold going back to 2000, a key rationale has been that investors would lose confidence in central bankers (notably Alan Greenspan--remember him?) and paper money.  That continues to be the case.

As savers in the U.S. continue to be penalized by negative "real" interest rates after inflation, a primary basis for higher gold prices persists.  Negative real yields on U.S. Treasury bills historically have coincided with rising gold prices.  There is no indication of higher rates in the U.S. or other developed countries, and even central bankers in developing countries are cutting interest rates to try to promote economic growth.  In essence, there is no opportunity cost to holding gold rather that cash that yields nothing.  Of course, if the 20-year bull market in gold ends, cash will look good.

The recent 19% decline in the price of gold bullion has been followed by a 6% rebound.  Last week, reports indicated a sharp increase in Chinese imports of gold from Hong Kong.  That buying, plus a likely end to major selling has supported the price of bullion.  Why did bullion fall 19% in price?  The near 30% year-to-date gain in bullion had left it vulnerable to profit taking, particularly in a year where many hedge funds had large losses elsewhere.

I think it is too soon to eliminate gold from one's portfolio.  Sentiment measures are depressed, commercial market participants (the "smart money") are buying, and real interest rates remain negative.  In addition, gold equities are quite depressed, despite an ongoing profit surge.  That is one sector that, in a slow-growth economy, has large profit gains ahead.  But as we saw in 2008, if stock prices fall sharply, gold stocks will behave like the equities that they are.

Steve Lehman

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