By Marc Davis
Why Betting On An Economic
Meltdown Is Enriching Gold Investors
Something wicked this way comes!
So say many leading stock market forecasters, who worry that a bubbling witches' cauldron of global economic woes is in danger of boiling over.
Consequently, the threat of a renewed global recession looms large, they warn.
This is why investors have been flocking en-masse into physical gold, gold-backed exchange-traded funds (ETFs), and long-neglected gold mining equities since January.
James Butterfill, head of research at the global asset management firm, ETF Securities, doesn't expect gold to lose any of its lustre any time soon.
"Investors are returning to gold as a core diversifier and safe-haven investment," he says. "Given the increasingly challenging investment and economic environment, we expect this trend to continue."
Gold and gold mining stocks are widely considered a safe-haven hedge against the prospect of economic meltdowns -- either in Europe, China, or even the U.S.
Also, the spot price of gold bullion typically acts as a reverse proxy for the U.S. dollar. Hence, the weakness of the greenback lately has driven gold higher. In fact, gold has risen as much as 22 per cent this year, spiking as high as US $1,293 on Friday.
Yet, asset-rich gold stocks have done far, far better. (More on this in a moment.)
Paul Ciana is another high-profile expert who suggests that this well-primed bull rally for gold is far from over. A technical strategist for Bank of America Merrill Lynch, he foresees a possible near-term jump to US $1,550 an ounce.
Among those gold stocks that have rallied lately is the ultimate poster boy for the gold industry, Barrick Gold (NYSE: ABX) (TSX: ABX), which is the world's largest producer. Its share price has more than doubled so far this year.
Now the trickle-down effect is being felt among Canada's smaller gold mining companies, as well as many aspiring gold miners. Most of these stocks have more than doubled in value since mid January. A few have done even better, with some tripling in value, or better.
In fact, investors are achieving considerable leverage over bullion's ascendant spot price by cherry-picking smaller, cheaply-priced gold producers, according to Kerry Smith. He is a senior mining analyst with the Toronto-based investment bankHaywood Securities.
"Investors who have done well with big gold stocks are now looking further down the food chain for under-valued smaller cap gold stocks," he says.
However, the mania for gold stocks isn't yet as pervasive as it promises to become, Smith adds. In other words, it has yet to catch on with a broader market audience -- the vast majority of investors who don't normally dabble in the gold sector.
In which case, there are still a few smaller gold stocks that have yet to see a parabolic rise in their share so far this year. One example is Toronto-Venture-Exchange-listed Amarillo Gold (TSX.V: AGC).
Company president Buddy Doyle says his company has long been neglected by investors. But he thinks that'll now change -- especially because gold assets have finally regained their lustre after a record-breaking four-year bear market for gold mining stocks.
His company has a shovel-ready gold deposit in Mara Rosa, central Brazil that contains over a million ounces. And Amarillo is now awaiting final governmental approval to build its mine, which Doyle says is "imminent".
Projecting an output of around 125,000 ounces of gold a year at a very low cost (almost half the industry norm), Amarillo represents a new vanguard of lean, mean gold miners that are poised to breathe new life into an under-performing industry.
This heralds a much-needed industry revitalization. In recent years, gold mining has been hampered by high production costs, razor-thin profit margins (or losses in many cases), and a sometimes problematic PR image.
Doyle hopes that new gold miners like Amarillo will be able to remedy all these issues, while also helping to give the gold mining industry a bit of a makeover.
"We've demonstrated our ability to become a profitable business, a good corporate citizen, and a conscientious environmental steward," he says. "These are key qualities that will help win over new converts to the gold mining investment sector," he says.
So why exactly are so many investors convinced that gold and gold stocks will enjoy a sustained rally? Ultimately, they're betting that the global economy will get worse and may even revisit the crises conditions that triggered the 2008 global economic meltdown.
Two key indicators of this gloomy outlook are the declining health of China's economy, as well as a prospective flare-up of Europe's drawn-out sovereignty debt crisis. And Europe's biggest economy, Germany, is now officially in a sickly state of deflation, according to the London-based Financial Times.
In addition, the unexpected and sustained plunge in oil prices is an unequivocally clear signal that the global economy is weakening. And that too has investors spooked
On the home front, the economic picture isn't much rosier. For instance, the U.S. Federal Reserve Board is flirting with the idea of adopting negative interest rates. Which is widely viewed as a desperate attempt to stimulate the stumbling U.S. economy.
It's the Feds' inability to kick-start the economy that's helping to propel gold higher, according to Joe Foster. He's a portfolio manager with a US $575 million gold fund at New York-headquartered Van Eck Associates.
"A weak economy and the inability to have effective monetary policy creates all sorts of financial risks, risks in the banking system, risks to the economy, and those type of systemic risks are what gold rises on," he recently told Bloomberg.
The recent weakening of the U.S. dollar isn't helping matters either because it erodes consumers' purchasing power, thereby dampening the U.S. economy further.
Furthermore, the number of palpable signs that the U.S. economy is slowing down just keep adding up. They now include a recent spate of disappointing corporate quarterly earnings, according to Kerry.
"This has all created an environment is which gold has not only reversed its downtrend but it's now rallying," he says.
Ironically, all of this economic malaise is music to the ears of gold bullion and gold stock investors. Many of them believe that the worse things get, the better these investments are likely to perform. And so far they've been right.