A Case for Gold

10/28/2005 12:00 am EST

Focus:

Jon Markman

Editor, Trader's Advantage

"Among most investors, the ascent of gold to 17-year highs has been greeted with a big yawn," notes Jon Markman. "If its goes much higher, though, it will begin to dawn on investors that something really important is happening." Here’s his assessment:

"Gold is as much about investors’ state of mind as it is about the status of mines. It is a set of beliefs and a world view as much as it is a shiny, malleable metal to wear around your neck, or pound into coins, or stow away in a safe-deposit box. When the stock market and real estate are performing well, gold seems too abstract to bother with. It is only when sentiment for equities and the dollar turn more bearish that precious metals begin to shine.

"Since the intrinsic value of gold is a real mystery to most peopleit doesn’t have a p/e multiple, and doesn’t seem essential to everyday life it goes through historical cycles of lust and indifference. My guess is that while now is not the time to chase it, patient investors will be rewarded by buying the next big dip either via the futures market or through the shares of gold-mining companies. Gold could correct, by as much as 15%, in step with higher US interest rates and the dollar.

"Over the next 12 to 36 months, though, after the Federal Reserve is done raising rates, it could go much, much higher. With so much rootless capital roaming the world in search of the next big trade, in fact, it wouldn’t take much a spark of love from the world’s new legion of momentum-oriented hedge funds to push this thinly traded market to levels well beyond the $800 bogey of the early ‘80s if inflation, sentiment and consumer-demand harmonize.

"Unlike stocks and bonds, it has been considered a store of value for more than 2,000 years. The gold bugs will tell you that an ounce has bought a man’s suit since the loincloth era. (Depending on where you shop, of course.) But the point is that regardless of whether a country’s currency is priced in dollars, lira, reichmarks or cockleshells, during frightful moments of value destructionsuch as periods of hyperinflation, war, or natural catastrophe gold has been acknowledged as a medium of exchange.

"At the end of the day, the price of gold, like anything else, goes up when buyers are more aggressive than sellers, particularly when supply is constrained. Whether you think marginal new demand is coming from central banks and private citizens hedging against incipient inflation, or from the jewelry aspirations of China and India’s swelling middle classes, the bottom line is that the long-term trend is up, even if there’s a long lull in the action before the next leg higher.

"There are at least four ways to take action. The most direct way to go long or short gold is to open a futures trading account. The advantage of buying or short-selling futures is that you are not dependent on the whims of mining company executives’ hedging or management skills, or on local permitting problems, or labor disputes. You can make a pure two-year bet on the direction of gold by putting up as little as 3% of the value of your account. Now that’s leverage.

"Moving down the risk spectrum, you could buy the shares of a small-cap mining company with good prospects. Scotia Capital analyst Michael Durose has outperform ratings on so-called ‘junior gold’ outfits like Golden Star Resources (GSS ASE), which has West African properties; and Agnico-Eagle Mines (AEM NYSE), which mines in Quebec and has programs in Mexico and Finland.

"Next come the larger mining companies, such as Newmont Mining (NEM NYSE), Barrick Gold (ABX NYSE) and Placer Dome (PDG NYSE), which tend to go up and down together, with a slight edge given to the first two by most analysts. And finally, you can buy shares of a gold-tracking exchange traded funds, such as StreetTracks Gold Trust (GLD NYSE), or mutual funds such as Fidelity Select Gold (FSAGX) or Tocqueville Gold (TGLDX). Whichever you choose, keep in mind that buying or selling gold is just a trade like any other not a mission, or a even an investment. Don’t try to earn a bronze star for heroism if it goes against you."

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