Gold Buyers a Rightfully Fearful Lot

04/26/2011 4:48 pm EST


Lawrence Roulston

Editor and Publisher, Resource Opportunities

With the prices of precious metals outpacing mining shares, this is no time to play the hero, writes Lawrence Roulston in Resource Opportunities.

The latest shock to the financial system came last week with news that Standard & Poor's issued a warning on its outlook for the US debt rating. The bond rating agency lowered the outlook for the present AAA rating to negative. According to Standard and Poor's, that warning implies a 33% chance of a negative rating change in the next two years.

The negative outlook was issued as US lawmakers appear stalemated in their efforts to find a workable means of reducing the ongoing deficit and the ballooning debt.

The US housing market faces still more years of weakness, and the unemployment rate remains persistently high.

Investors around the world dumped shares of US companies following the news-but after the initial shock, share prices largely rebounded, as the warning was hardly a revelation.

S&P's action will undoubtedly increase downward pressure on the US dollar. Gold and other metals will benefit from that negative outlook.

For one, a decrease in the value of the dollar results in an immediate increase in the nominal price of commodities, as measured in dollar terms. More significantly, growing concerns over the security of paper assets like US debt are generating an increasing level of interest in hard assets, with gold at the top of the list. The ongoing concerns in Europe add to the general unease with regard to currencies.

To seek safety in gold, investors are going directly to the physical metal. Bar sales have grown rapidly, while the net holdings of exchange-traded funds have declined. Gold equities, for the moment, are also losing their role as a proxy, as investors seek a high level of security.

As bullion continues to appreciate, the share prices of gold companies will bounce back to reflect the underlying values based on the rising gold price.

Gold and silver have both had long runs of uninterrupted gains. While the outlook for both remains positive, investors should prepare for some volatility.

More than ever, this is a time to be extremely selective in gold and silver equities. It is important that the companies have potential for gains in asset value independent of the moves in the metal prices.

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