Goldilocks and the three bulls agree: gold is cheap and gold stocks are cheaper

Today, we tackle a tough question. Tough for gold investors, that is.

After an extraordinary run in the gold price, is gold overvalued? Are its best days behind it? Have you missed your chance to invest?

When some customs officials tried to confiscate my gold in 2011, they didn’t believe me that an inanimate object had outperformed the stockmarket. Even their subsequent apology letter didn’t acknowledge it.

So I better start today’s Exponential Investor by describing just how well a lump of the metal would’ve served you in the past. Most people simply don’t realise what has happened.

Over the last 20 years, gold is up six and a half fold in terms of pounds. The FTSE is down slightly over the same period. Although many of the companies in the index have fallen out, leaving investors with far worse performance.

To be clear, an inanimate object outperformed corporate Britain’s pride and joy. And I’ll bet you that your financial adviser and stockbroker don’t know this.

The chart shows why gold has earned a place in Exponential Investor’s editorial:

Source: Goldprice.org

I’ve added the location of Gordon Brown’s famous bottom too. That’s when the former chancellor sold half of Britain’s gold. At the worst possible moment and the lowest possible price. And got promoted to prime minister for his savvy.

When MEP Daniel Hannan called him “the devalued prime minister of a devalued government” in 2011, he should’ve meant it literally.

Long-term readers will be disappointed to hear that our attempt to brew a Brown Bottom Golden Ale is on hold, for now.

Back to the gold price.

After that outperformance, I can’t fault you for thinking gold must be overvalued.

But there are three reasons why I believe gold’s bull market will continue – why it’s in the Goldilocks zone for buyers. Let’s call them the three bulls.

The first is interest rates and dividends.

Gold’s detractors like to point out that you can’t eat your gold. But, of course, you can. My wife comes from a part of Japan famous for its gold leaf manufacturing.

Gold detractors respond to this rebuttal by pointing out that gold doesn’t even pay interest, like cash at a bank. Gold investors point out that cash at the bank doesn’t really pay much any more either. In some places, they charge you money for your large deposits. And that’s why gold will soar – the opportunity cost of owning it is shrinking fast.

These days, large cash savings are at risk in all sorts of ways. Negative interest rates and bank bail-ins, for example. Anyone looking to diversify away risk should have some exposure to gold because of this. It’s not like it’s a binary choice. Although that’s how gold’s detractors like to argue the case. As though owning nothing but gold is a good idea…

But what about dividends? Owning gold doesn’t pay those?

Well, if our gold stock analyst is right, this gold stock could be about to provide the biggest dividend hike of 2020. Which doesn’t sound like much given other companies are cutting dividends. Or even being forced to suspend them after bailouts.

But that’s the whole point of owning mature gold stocks. They can turn gold’s crisis fighting potential into an income stream boost. Income investors need to own at least some gold stocks to stabilise their income sources too, just as capital gains focused investors should own gold.

The second reason gold has further to run is simple. Few people own it – it’s still under-owned by investors.

Now, there are plenty of calculations floating around to figure out just how under-owned gold is. And they all use a different premise.

For example, given the gold market’s size, investors who diversify should have exposure to gold. Or, given gold’s performance, not owning gold is simply missing out on a financial asset that has outperformed.

But all these measures assume that information on who owns how much gold are correct. Which I doubt very much. One of the reasons to own gold is that it can be kept out of the statistics.

Whatever the logic and methodology, the implications are the same. If investors did begin allocating their wealth to gold, the demand would spike the price. And we have a long way to run in the gold price going by that pent-up demand.

This is especially true given that gold ETFs are becoming preferred to futures speculation. It’s easy to fudge gold prices in the futures market. But many ETFs buy physical gold itself. And that can move markets too.

Reason number three is that gold is money. Its value doesn’t’ really change, in the long run. It’s everything else that’s fluctuating around all over the place.

Gold’s value, priced in the stuff you want to buy with money, remains remarkably stable over time. That’s why people used it as money for thousands of years, especially after the most recent attempt at fiat money collapses each time.

But what does this tell us about gold’s valuation now? Well the global money supply didn’t take a break on its path upwards. But the gold price, in US dollars, took a hit since 2012 before the recent rally.

Source: Zero Hedge

This suggests gold is undervalued relative to the amount of money sloshing around the system.

Goldilocks and the three bulls assure you, now is the time to buy the yellow metal.

But buy what?

Holding physical gold is a crucial part of any portfolio, if you ask me. It’s one of the few assets that can outperform in both a deflationary and an inflationary shock.

But, if I’m right about a new gold bull market, there’s an even better way to profit.

Nick Hubble
Editor, Southbank Investment Research

Category: Commodities

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