Sunday, December 28, 2008

Five Sophisticated Gold and Silver Investment Strategies for 2009

Buying a few gold coins or the odd mini-ingot and hiding them away has been a successful investment strategy over the past five years. Even in the annus horribilus of 2008 investors who chose gold over other asset classes have been well protected while others have seen their wealth decimated. US dollar gold prices have been maintained while gold in Australian dollars, for example, was one of the best performing global asset classes in 2008.

For 2009 the resumption of a strong bull market in gold is one of the few positive predictions that look reliable. The sell-offs by hedge funds which kept gold future prices down in 2008 are coming to an end, and that should unleash a powerful new up leg in the gold market.

Chartists can already see this happening in their technical analysis. The spot price of gold has moved above the futures price, something known as ‘backwardisation’. This is almost always a signal that a huge price shift is about to occur. The same ‘backwardisation’ is also present in the silver price chart.

Soaring demand

You can also see this in the demand for physical gold that has been soaring. Last months a group of Saudi investors bought a $3.5 billion hoard of gold, one of the largest single deals ever, and smaller investors have been snapping up precious metals all over the world, leading to shortages of many popular bullion coins and delivery delays.

What is gradually happening is that physical demand for gold is overpowering the paper or futures market in determining the spot price for the yellow metal, that is what ‘backwardisation’ means down on the ground, and once the futures market is sunk the gold price will leap back above the high of $1,030 set last March.

Aside from sensing this change, why is it that smarter investors are so keen to invest in gold now? It is really down to the condition of the global economy and the massive amounts of money being injected by governments to counter the slump in bank lending. Investors reason that not too long down the road, this action is going to be inflationary, like in the 1970s.

Gold has a relatively fixed supply and so will retain its value as price levels soar, and in fact this phenomenon will attract new investors to the yellow metal and send prices very much higher. In the late 1970s the gold price rose eight-fold, and history has a habit of repeating itself, whatever governments try to do to keep prices down.

But the smarter investor is going to want to find a way to leverage the rising gold price in 2009 and to achieve the greatest returns without necessarily putting capital at risk through debt-funded instruments. There are a number of well-proven methods of achieving this kind of zero-debt leverage to the gold price.

Gold stocks

First, you can buy gold stocks, the shares of large gold producers. Conveniently the recent stock market crash has taken these share prices down to low levels, marking an attractive entry point for investors.

Buying gold stocks levers the gold price because as the gold price rises it has an even larger impact on the profits of gold producers. Clearly any rise in the gold price above the cost of production flows straight through to the bottom line.

Secondly, junior gold stocks or gold exploration stocks offer a riskier investment class – as smaller companies with less certain assets and management – but a proportionately higher return. Gold exploration companies own the claims to land on which future gold mines might be located, and in a gold boom the value of these assets rises exponentially.

Legendary investment adviser Dr. Marc Faber recommends gold explorers in his latest newsletter, pointing out that these stocks have become ‘incredibly cheap’ because of the stock market crash. In the late 1970s investors who bought the right gold juniors at the right time made one hundred times their original investment.

Thirdly, instead of buying gold you could buy silver. These two precious metals are close cousins and it is not for nothing that silver is often referred to as ‘poor man’s gold’.

In previous gold price booms, silver has always tended to outperform gold in terms of its price rise. People who cannot afford gold tend to buy silver and it is a fact of life that the available stock of silver is much smaller than gold, and so the price rises are more dramatic as demand lifts off.


Silver price movements can be very volatile as investors have seen in 2008, but the reward for patience is higher returns than gold. Chartists note that silver price movements tend to lag gold in the early months of a major price advance and then suddenly sprint ahead, bringing down the important gold-to-silver price ratio.

The gold-to-silver price ratio stands at around 66 today compared with its long-run average of 15. This leaves considerable room for a closing of the gap between the gold and silver price, and that will come on top of an increase in the gold price. Owning silver therefore gives a strong leverage over the gold price.

Fourth, the sophisticated investor can look to gear-up on the silver price by buying stock in the major silver producers. This is how investors like Warren Buffett, Bill Gates and George Soros have played a rising silver market in the past. The same argument applies as with the gold producers, as profits will be geared to the rising price of the underlying metal.

And here is a fifth and final option for smarter investors in precious metals: you could buy shares in the smaller silver producers, or silver explorers, whose share price advances in a bull market will eventually be bigger than the larger integrated producers. Again in a real bull market the value of the assets of smaller companies will leap, and these shares are presently very cheap after the stock market crash.

However, one big warning to smarter investors who want to leverage the gold price in 2009: leverage, even without debt, will act in reverse if the gold price falls. So a diversified portfolio of precious metal assets is preferable to limit downside risk.

Also you should note that this article has not even considered ways of levering the gold price by borrowing cash for investment. Gold is not for market timers whose leverage depends on precisely timing options, and silver is even more volatile.

No debt

The trick is to keep the price movements working for you by holding the right type of investment instrument and not borrowing up to the eyeballs or using options to try to lever a small price change that might not happen exactly when you want it.

Think of precious metal exploration stocks as an option that never expires, or at least one that does so very slowly, but do not buy precious metal options unless you happen to be in the jewelry trade.

However, the sophisticated investor is paying more and more attention to precious metals and trying to exact the best performance from this asset class is something that is taxing the best brains in the business right now. It maybe that top managers come up with some better ideas than those presented in this article, but these are all the approaches that have worked in past precious metal booms.

1 comment:

Peter said...