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If the
investment choice is between mining stocks and physical bullion, it is essential
to remember that these are different asset classes with entirely different
risk/reward attributes. Mining stocks and bullion perform quite differently
when the global economic environment is in turmoil, as is the case today.
Banking crises, trillion-dollar deficits and the accelerating depreciation of
many of the world’s major currencies do not create positive conditions
for equity markets, which is why investors are fleeing to the safety of
physical bullion.
Bullion
is a safe haven during turbulent times
This
flight to bullion was confirmed during the stagflationary 1970s. Figure 1 shows that
while Homestake Mining, the shares of the largest North American producer at
the time, increased by an impressive 800 percent during the 1970s, physical
gold increased by 1,500 percent, during that same time period. While it is
true that many junior mining companies outperformed both bullion and
Homestake in the 1970s, producing impressive returns for their shareholders,
many other juniors faded into obscurity, resulting in painful losses. The
volatility associated with junior mining companies versus blue chip producers
and physical bullion makes them a purely speculative choice. However, if you
have a high risk tolerance and a good advisor, then a small allocation to
junior mining companies may be appropriate, especially those with established
ounces in the ground. Juniors with a new discovery can generate substantial
capital gains, but they are still highly speculative investments and can be
very volatile.
Bullion
outperforms mining stocks during financial crises
While
mining stocks can generate impressive returns during an uptrend in precious
metals prices, they do not outperform bullion during times of crisis, as in
the financial meltdown of 2008, for example. Figure 2 shows the relative performance
of the XAU mining index against gold bullion. When global economic
conditions deteriorate, investors inevitably seek a safe haven for their
wealth, rather than more speculative investments. As can be seen in Figure 2, gold
maintained its strength throughout the turmoil, even as financial markets
and mining stocks (as represented by the XAU Index in purple) declined.
Blue
chip gold stocks like Goldcorp and Barrick Gold can be good investments
because, unlike juniors, they are less likely to wither away to nothing and
frequently offer dividends. But timing is crucial because producers can
also be quite volatile. Other precious metals investment options might include
mining ETFs which holds a basket of gold producers, but be prepared for a
daily roller coaster ride. Regardless of the type of investments chosen,
every investor’s portfolio should be diversified with precious
metals.
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Bullion
held its own during the 1987 market crash, while mining stocks fell
During
sharp market declines, such as the 1987 stock market crash, mining stocks
tend to become correlated to the broad equity markets rather than the price
of bullion. Figure 3
shows the comparative performance of mining stocks, gold bullion and the
Central Fund of Canada (CEF), a closed-end fund that holds gold and silver
bullion, during the crash. As the chart shows, mining stocks declined more
than the Dow even though the price of gold was rising. The exchange-traded
Central Fund behaved like an equity even though it holds bullion.
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While
mining stocks have significant appreciation potential beyond the price of
bullion, they are leveraged plays on bullion prices, and like any form of
leverage they carry a variety of risks. In addition to stock market
volatility and deteriorating economic conditions, potential risk factors
include: geopolitical issues, environmental issues, management skills and
performance, business model, financial strength, mine life, production
costs and efficiencies, increases in operating and energy costs, hedging
policies and exploration success.
Gold
bullion is not an investment
Many
investors jump on the gold bandwagon without taking the time to assess
whether they are savers seeking wealth preservation or speculators seeking
capital gains. Mining stocks, especially juniors and exploration companies,
tend to be for speculation, while bullion is about wealth preservation. But
physical bullion should not be viewed as an investment. An investment is
defined as an asset that is expected to produce earnings or capital
appreciation at a later time. Bullion does not pay dividends, income or
interest, and should not be held, primarily, for capital appreciation. If
bullion isn’t an investment, what is it and why does it continue to
rise in price?
Gold
is money
Gold
is primarily a monetary asset. It has been a universal medium of exchange
and store of value for three thousand years, and it backed every major
world currency until the twentieth century. The reason for gold’s
“rise” to prominence in recent years has little to do with the
metal itself; it is occurring because gold provides the ultimate protection
against economic mismanagement and currency destruction. In an era of
rampant currency creation, gold has resumed its historical role as money.
For a full explanation of this phenomenon, go to: “Gold is
Money” (www.bmgbullion.com/document/682).
The
“cash” component of every portfolio
Because
gold and other precious metals do not depreciate in the long term, it
should replace the depreciating “cash” component of every
investor’s portfolio. Physical, allocated bullion is the foundation
of the precious metals investment pyramid (Figure 4) and, given current
conditions, it offers more safety and security than government bonds,
T-bills and other traditional cash components.
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Gold
is the anti-currency
In
an era of fast money and currency destruction, bullion is real money.
Central banks are buying bullion, hedge funds and other institutional
investors are buying bullion. And the world’s largest creditor
– China – is diversifying out of dollars and buying bullion.
“When
the price of gold moves, gold's price isn't moving; rather it is the value
of the currencies in which it's priced that is changing.”
–
John Tamny, economist, H.C. Wainwright Economics
Most
investors’ portfolios are heavily weighted in currency-denominated
financial assets (stocks and bonds), but few comprehend the extent of their
purchasing power loss. The numbers in Figure
5 may help put things in perspective: in the past ten years, the
US and Canadian dollars, the UK pound and the euro have, collectively,
fallen more than 70 percent in value if measured in that universal unit of
money, gold. In effect, investor portfolios have lost 70 percent of their
purchasing power. Currency destruction, while it is accelerating, is by no
means a recent event, however. Since 1913 (not coincidentally the year the
US Federal Reserve was formed) the US and Canadian dollars have lost a
staggering 96 percent of their value. Is this trend likely to come to an
end? Not in the foreseeable future.
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Sovereign
debt grows, but Greece is not the problem
The
debt problems in Europe in general, Greece in particular, Japan and the UK
should be of grave concern to all investors. As the crisis widens and
deepens, all currencies are coming under pressure. The US dollar is rising
because it is currently perceived to be the least ugly of an ugly bunch.
But is it? America's budget deficit (13 percent of GDP) is nearly identical
to that of Greece, and its debt as a percentage of GDP is not far behind.
And America’s problems are one hundred times the size. In 2009, the
US incurred a budget deficit of $1.4 trillion, and its debt rose by $1.9
trillion due to off-budget expenditures. These off-budget expenditures
alone were more than the 2008 budget deficit.
At
the end of 2009, America’s total debt was approaching 100 percent of
GDP, but most investors are unaware of another, far bigger burden:
trillions of dollars in unfunded liabilities for Social Security, Medicare
and Medicaid. Money the government promised to taxpayers for Social
Security has instead been borrowed for its own use. Money the government
promised to fund future Medicare and Medicaid benefits and
military/government pensions has not been set aside at all. Richard Fisher,
a member of the Federal Open Market Committee, believes total US debt
– including Medicare and Social Security – is over $122 trillion
(Figure 6).
This is more than $390,000 for every man, woman and child in the US, and
the number keeps rising.
“Fiscally,
we are in uncharted territory. Because of this gigantic deficit, our
country’s ‘net debt’ is mushrooming… no one can
know the precise level of net debt to GDP at which the United States will
lose its reputation for financial integrity.”
-
Warren Buffett, Chairman, Berkshire Hathaway
When,
not if, interest rates rise from their present near-zero levels, US debt
payments will soar because every percentage point rise in interest rates
adds an additional $120 billion in interest payments. And if inflation were
to take hold, rates could easily rise to 10 or 15 percent, as in the 1970s
stagflation era. If that were to happen, interest payments alone would
gobble up over 90 percent of government tax revenues. With this kind of
economic future on the horizon, is it any wonder the US dollar is in
irreversible decline?
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A
much bigger crisis awaits
Current
economic conditions are ripe for the onset of another, even bigger
financial crisis. Zero interest rates, trillion-dollar sovereign debt,
trillion-dollar bailouts and stimulus spending are almost certain to result
in spiralling inflation, which could lead to a hyperinflationary
depression. Economist John Williams delves into this growing possibility in
his Special Report on Hyperinflation - 2010 update. (www.shadowstats.com/article/hyperinflation-2010)
“It
is absolutely inevitable that the US will have to ‘default’ on
part of its existing liabilities, since the long-run trajectory of
government borrowing is clearly unsustainable.”
- Niall Ferguson, author, The Ascent of Money
As
confidence in fiat currencies continues to decline, gold prices will rise
causing mining stocks to rise as well.
It’s
time to preserve your portfolio’s purchasing power
In a
world of increasing volatility and uncertainty, precious metals bullion
provides tangible, predictable wealth protection for currency-denominated
investment portfolios. For the past several years, as currency creation has
reached unprecedented levels, gold, silver and platinum have resumed their
traditional role as a store of wealth. Over time, purchasing, or adding to,
a core holding of physical bullion is a prudent investment strategy. While
a minimum 10 percent allocation is considered adequate under normal
conditions, a much larger allocation of 20 percent or more is suggested for
protection today. If you have not already done so, now is the time to
rethink your investment strategy and preserve your hard-earned wealth with
physical bullion.
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Nick Barisheff
Bullion Management Group
Nick Barisheff is the
co-founder and President of Bullion Marketing Services Inc., which was
established to create and manage The Millennium BullionFund. The fund is
Canada’s first and only RRSP eligible open-end Mutual Fund Trust that
holds physical Gold, Silver and Platinum bullion www.bmsinc.ca
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