The Wisdom of Yukon Cornelius.

September 4, 2013

"Shall we turn the earth to gold? The rivers, the mountains, the stars, the moon, the sky... a universe of gold!"
-King Midas in the film, The Golden Touch

. . .
I prefer silver to gold. Silver watch. Silver ring. Silver hair. Silver cars. The Silver Surfer. Silver cuff links. Ron Silver the actor.
My favorite childhood cowboy, The Lone Ranger, named his horse Silver. Of course, he also wore a black eye mask, a neck kerchief and a tight blue suit. So, his preferences are suspect.
Personal preferences aside, man has long obsessed on gold. Pirates hunted it. Merchants traded it. Colonialists killed for it. Governments hoard it. Thieves steal it. Rappers have integrated it into their dental plans.
Gold is an accessory. A decoration. An asset. A currency. A liquid and solid. A symbol.
Gold is victory and tragedy. Past, present and future. It threads together the centuries, one to the next. Reveals us for the greedy, artistic, lustful and ambitious creatures we are.
As a child, I recall sitting before the television at Christmas, singing, "Silver and gold, silver and gold..." Because like the kings, merchants and pirates of lore, Yukon Cornelius also loved gold.
Yukon Cornelius, the affable arctic prospector made famous in the 1964 Christmas special, Rudolph The Red Nose Reindeer, set off to find his fortune in gold. Yet, upon meeting Rudolph and his gang, Yukon soon finds out that true fortune oft emanates from unlikely sources.
We have recently made similar observations.
The Rise and Fall of Gold
Following the 1970's collapse of the Bretton-Woods system, the price of gold skyrocketed. Rising from $35 to more than $600 per ounce by 1980. Following, there was a stable period throughout the eighties and nineties. Gold fluctuated between $300 and $400 per ounce. Following the inception of gold ETFs in 2002, prices jumped again. Rising to $1,900 per ounce by 2011.
Successful gold investing relies upon an understanding of what the metal is, and is not. Likewise, successful gold speculation relies upon one's ability to determine what humans are, and are not. To accurately understand and predict investor psychology.
Here, 99.99 percent of us fall short.
Fundamentally, gold prices rise and fall based upon a litany of factors.
Gold is impacted by exchange rates.
Typically, a weaker U.S. dollar will cause gold to rise in value. As the dollar weakens, investors seek to preserve purchase power. So, they buy gold. And prices rise.
Gold is impacted by geopolitics.
Gold is a safe haven instrument. When geopolitics becomes volatile, investors seek the safe haven status of gold. For instance, when the U.S. and its allies invaded Iraq in 2002/2003, the price of gold rose sharply.
Gold is impacted by supply and demand.
In 1998, when European central banks announced that they would reduce gold reserves in preparation for the adoption of the Euro currency, the price of gold plunged. Less demand. Same supply. Prices decline. Simple economics.
Gold is impacted by the global economy.
Roughly 80 percent of the world's gold supply is used by the global jewelry industry. So, jewelry consumption has a major impact on demand. When the global economic situation is bullish, jewelry demand increases, and so does the price of gold. When the global economy is down, the inverse situation occurs.
Gold is impacted by interest rates.
When interest rates rise, people begin to deposit currencies into interest-bearing accounts and vehicles. As demand for gold falls, so too does its price. When interest rates fall, investors look to preserve capital, and gold demand increases. As do prices.
Current Events and the Price of Gold
Despite massive amounts of stimulus, GDP growth remains anemic. In fact, the Fed has tried everything short of Viagra to get raise GDP. Unemployment remains high. Durable goods orders have cratered. And rising interest rates are beginning to harm the housing rebound.
This, the byproduct of record-low rates and trillions in quantitative easing (QE).
That said, most analysts expect the Fed to begin tapering bond purchases this month. What would the economy look like if the Fed wasn't buying $85 billion in bonds each month? Skyrocketing interest rates? Declining stock markets? Falling household wealth? A collapsing housing market? Frozen credit markets? An increase in unemployment? Foreign nations dumping U.S. Treasuries?
And I'm an optimist.
While the Fed originally called for an inflation bounce as part of the justification to end QE, official indicators reveal that headline and core CPI remain below 2 percent. Not the inflation levels that typically compel policymakers to end stimulus programs.
What does this have to do with gold?
It appears that much of the recent selloff in precious metals was largely based on the assumption that Fed bond buying will soon end (or significantly decline, also known as tapering). As these prognostications became accepted, gold and silver prices fell to multi-year lows amidst the worst correction of what has been a 12-year bull market.
Was the selloff justified?
Like Tammy Fay Baker, it was overdone.
We believe there is a chance that the Fed concludes its September meeting without a tapering announcement. In fact, given the underlying fundamentals and fears of an increasingly DOA housing market, the Fed could even announce an increase in QE, endeavoring to push rates down, spur employment and elevate inflation to more desirable levels.
This scenario would likely bring an explosive bounce in precious metals.
And even if the Fed decides to taper, it will likely be a token amount. Investors may see this as the Fed's tacit belief in an improving economy. Concurrently, the Fed will likely leave most of the QE program in place. Indefinitely. This would also be bullish for gold.
Time to Buy Gold?
There are three means of investing for a prospective gold recovery.
First, investors can purchase shares in a gold ETF or index, like GLD. These indexes closely track the spot price of gold and generally capture its ups and downs.
Second, investors can buy physical gold. We work with companies like Hyde Park Rare Coin when doing so.
Third, investors can buy shares in gold mining companies, or in mining indexes, like the Market Vectors Gold Miners ETF (GDX).
Yukon Cornelius? He was a do-it-yourselfer. Loved digging for gold. But, I've an inkling that he would have opted for option three.
Please recall how Yukon and Rudolph foiled Bumble the Abominable Snow Monster. By erecting a makeshift trap above Bumble's cave entrance, they were able to "leverage" the weight of the snow above to bring him down.
Accordingly, gold mining companies tend to be leveraged proxies for the underlying precious metals they seek, produce and sell. As a fan of leverage, Yukon may have forgone his passion for mining, and simply bought the mining stocks.
Gold mining stocks have been decimated the last few years. Down 60 percent since 2011. In fact, when gold is down, and the gold mining companies are pulling a lower-priced product out of the ground (at no less production expense to themselves), the shares usually get clobbered.
When Everyone Hates It? Time to Buy It.
Gold mining stocks are unloved, unwanted and undervalued. Which makes for one hell of an investment theme.
Realizing that the best time to buy is when something is most detested, now may be a great time to consider gold miners. Sentiment could not be worse.
These stocks become even more attractive when one recognizes that, as gold rises (we think it will), these minors realize quantum leaps in profit margins.
Stable input costs and rising output (gold) prices equate to higher profitability. This explains why the mining companies can often serve as a leveraged means of playing the underlying metals. Anecdotally, when gold rose 130 percent from 2008 to 2012, the Market Vectors Gold Miners ETF (GDX) rose 183 percent.
Also supportive of gold and the gold miners is the fact that three of the largest five populations in the world love gold as much as Mr. T.
China, India and Indonesia love gold. In jewelry. Household decorations. And in savings accounts. Further, the governments of five of the largest 10 nations in the world have been frenetically adding to their gold reserves. All of which is bullish for gold. And gold miners.
So, if you seek an investment that offers positive economic, geopolitical and valuation attributes, then perhaps it's time to consider a small allocation to gold.
Or, perhaps you've learned the lessons of Yukon Cornelius. That fortune is often found beyond one's initial objectives. If that's the case, then maybe the gold miners merit your consideration and analysis.
Happy prospecting.

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