Back in the old days, every good financial planner worth their...

Back in the old days, every good financial planner worth their salt would have recommended that a truly diversified investment portfolio contain at least 10%-15% of gold or gold stocks. This would have included a portion in real estate (not REITs), stocks and bonds.

Generally speaking, there are different reasons why a person would hold each type of asset. Stocks would be held for "long-term" capital appreciation. Bonds would be held for income and real estate would be the inflation hedge. Gold on the other hand would be held if the government couldn't pay its debts. You would never really want to be in the position of having to cash in on your gold position for obvious reasons. Instead, gold would be something that you pass on to your heirs as a just-in-case insurance policy.

I consider myself a precious metal investor of the most basic type. I do have 15% of my portfolio in gold and silver but I don't invest in gold and silver stocks. I consider precious metal stocks perpetual call options on the price of gold or silver. Therefore, I only speculate in the top gold and silver stocks, Barrick (ABX), Newmont (NEM), Agnico Eagle (AEM), Hecla Mining (HL), Silver Standard (SSRI) and Coeur D'Alene (CDE), when I see that the opportunity exists or that an "unimpeded" precious metal bull market is in place. Otherwise I stay out of precious metal equities.

Why do I stay out of gold equities except for the occasional speculative urges? As indicated in my previous articles on silver, dated November 25th, and gold, dated November 17th, there are market factors to consider before committing money to such a volatile portion of my investment portfolio that is dependent on both the price of gold going up and the general stock market not going down.

What confuses me about "gold bugs," as opposed to gold investors, is that as well informed as they are, gold bugs will not acquiesce to the idea that, generally, gold and silver stocks don't, can't and won't go up during a general stock market decline of 10% or more. Some gold bugs are willing to reference periods like 1929-1932 as a rationale for why gold is a necessary hedge during a stock market collapse. To respond to such spurious claims from the gold bugs, I have included the price history of gold and silver stocks from 1924 to 1933. This data is from Poor's, the company that pre-dated the merger of Standard and Poor's.

The price data of the 21 precious metal stocks is resounding since it puts to rest the idea that a decline in the general stock market would result in an increase in the price of gold and gold stocks. Even with the price of gold being fixed at a $20.67 per ounce, investors were not overwhelmed by the idea of jumping into gold stocks as the highest quality blue-chip stocks crashed 89% from 1929 to 1932.

Notice that some gold stocks ran up in price and peaked before 1929. For the remaining stocks that did peak in 1929, take a look at the high and then the low in 1930. All of these stocks fell by at least 50% during this two year period. Some stocks would stabilize, while the majority would collapse until 1931 or 1932. Once hitting their bottom in 1931 or 1932, the stocks would then recover, along with the rest of the stock market. The only gold stock from this era that still trades on the New York Stock Exchange is Newmont Mining. Newmont went from the hefty price of $236 in 1929 to $4.63 in 1932. After 1932, all stocks started moving much higher regardless of the industry group the company was in.

The lone glaring exception to this survey is Homestake Mining. I would have loved to have bought Homestake in 1924 at $35 and never have to watch it fall back to where I got in. However, Homestake is a special situation that is completely unrelated to the general conditions of the market. Homestake Mining has become the rallying cry for gold bugs despite the fact that there are numerous special situations that can be pointed out in other industries during the same timeframe. Homestake Mining will be the subject of future postings on this blog for an understanding of the reason(s) why it went up in price in the face of a crashing stock market.

The only reason that gold was a place where money flooded in periods of panic (1807, 1819, 1826, 1837, 1842, 1861, 1865, 1876, 1884, 1893, 1904, 1907, 1932) was because of government price fixing. If I lived through a panic during any of the prior periods and found that everything was falling in value but the official price of gold was being propped by the government then, of course, I would seek safety in gold. However, without a gold standard, the price of gold has proven to be at the whims of the market as a commodity. Unfortunately, gold bugs have mistaken gold as a safe haven during a panic for the wrong reason. This explains why James Dines, the world’s most renowned gold bug, openly wondered in his October 31st newsletter, “…why aren’t the prices of gold and silver commodities higher…”

Again, when the general stock market declines 10% or more then gold and silver will likely fall as well and may actually lead the decline on a percentage basis. The purpose of these articles on gold and silver is ensure that the money invested is done with an understanding of the forces in play. Gold bugs, understanding the dire nature of the government's fiscal and monetary position, might not be taking an investment position in gold but protection against the government recklessness. For everyone else, gold and silver are true commodities and should be treated as such.

The long term trend in gold and silver stocks as demonstrated by the Philadelphia Gold Stock Index [XAU], which was initiated in November 2000, will eventually head permanently higher. The continuation of that trend will be among the key indicators that the bear market in stocks is at or near an end.

Sources:

Dines, James. The Dines Letter. October 31, 2008. page 4.

Poor's Publishing Company. Poor's High and Low Prices 1924-1934, 1934 Edition. 1934.
Source of Article:http://seekingalpha.com/article/109814
Thoughts on gold equities worth considering.
Regards
Buffett