Is it Time to Buy Gold?

By Dr. Thomas Carr | June 4, 2015 |

My Grandfather was a very conservative investor. His investment capital was tied up in real estate, treasuries, the bluest of blue chip stocks, and gold. I remember well his argument for buying gold. “God only put so much of it in the ground,” he would say. “So it can only get more valuable.” For him, gold was the perennial answer to every financial problem. Inflation? Buy gold. Recession? Buy gold. A volatile stock market? Buy gold. A weak dollar? Buy gold.

Unfortunately, he didn’t live long enough to witness the great gold rally that began shortly after his death. From the $255/oz. spot price low of 2001, the price of gold (POG) rallied to an alltime high of $1,923 high of 2011. Over those 10 years gold averaged a whopping 65% ROI per year, far surpassing stocks and bonds combined. Silver nearly doubled that rate, of course, but it has never had quite the allure of the yellow metal. See the 10-year monthly chart below:

THE GREAT 10-YEAR BULL RUN IN GOLD

Look at the weekly chart of spot gold today and we see a very different story. The present story of gold is of a market in sharp decline. The POG recently dipped to near 1130, a drop of over 40% from the highs. This may be due to the stock market hitting new alltime highs, or the dollar’s rebound, or simply a lack of inflationary fear. Regardless, gold has been in a slump for the better part of three years, as the weekly chart below shows clearly:

3-YEAR SLUMP IN PRICE OF GOLD

So is this now the time to buy gold? With the POG near three year lows, and with stocks just under alltime highs, gold may well be the best bet for the second half of 2015 and beyond. Long-term buying opportunities in a major asset class like gold normally only come along once a generation. This may be this generation’s window of opportunity to own gold at a steep discount.

Here is the bullish case for buying gold now:

1. Price is way oversold. The monthly CCI recently hit a low of -270, its lowest point since 1997. The monthly MACD (-62) is near its all-time lows.
2. Selling pressure is abating. 2013 and 2014 saw the heaviest selling volume in more than two decades. So far in 2015, selling pressure is way down and the volume balance is rising, indicating more buying than selling is going on.
3. Inflation is coming. With current US debt levels historically huge and rising, we should start to see inflation and a weaker dollar going forward.
4. Stocks are overdue a correction. Since hitting the post-crash bottom in March, 2009, stocks have been on a strong upward trajectory. When the inevitable correction comes and volatility rises, this will make gold more attractive as a safe haven.
5. China is buying gold. China has recently emerged as a large buyer of gold. There are rumors that the central government wants to back the Yuan with gold in order to make it the world’s #1 default currency.
6. Wild moves in Currencies. Volatility in the forex pairs has spiked considerably since last December (like the Swiss Franc earlier this year). This makes gold more attractive as a safer place to put cash than currencies.

So how should we play an expected new bullish run in gold? If you are lifetime buyer of gold, there is nothing like owning the real thing. But today investors have several options that cancel the risks of owning physical gold (which can be lost or stolen). They are:

1. Buy GLD, the SPDR fund which tracks the spot gold price
2. Buy DGP (my preference), the 2x leveraged ETN for spot gold
3. Buy UGLD, the 3x leveraged ETN for spot gold
4. Buy calls on GLD (neither DGP nor UGLD is optionable)
5. Sell puts on GLD (more conservative, but upside is limited)
6. Buy a company that mines gold. Your safest plays here are: GG, ABX, NEM, FNV and AEM.

Like any investment, buying gold carries risk. There is the possibility that, having gotten all the bullish points correct, gold still moves sideways for the next few years, increasing your opportunity costs. It is also possible that the bulls are wrong, which would likely lead to a loss of capital for gold investors. Here are the risks in buying gold now:

1. The China thesis turns out to be false. China’s government insists that its gold reserves have remained steady since April 2009. And even if they are buying gold, they only have 1.3% of the world’s reserves, while the U.S. has 73%. That’s hardly enough to back a currency.
2. The U.S. Federal Reserve begins to slowly hike interest rates. This is already in the cards for later this year, and it is likely to keep inflation in check indefinitely, thus negating the “gold will rally on inflation” thesis.
3. The stock market doesn’t crash. The market can certainly continue its long-term, low-volatility ascent up a wall of worry for several more years, making gold less attractive than stocks.
4. New mining technologies are created. When it is easier and cheaper to get gold from the ground, supply increases and prices go down. This is already partly responsible for keeping gold prices in check for the past three years.

So, if you do venture in gold, I suggest you go lightly, average in your costs basis over time, and don’t give up on stocks until you see the current uptrend violated.

Disclaimer: any forward looking statements in this article are for educational purposes only. No recommendation is being made for the purchase of any security or commodity. The author may or may not have a position in one or more of the companies or commodities mentioned in this article. Please understand that trading involves financial risk.