Is this the right place to be?

The Gold Price has fallen 25% from its high of $731 in the last few weeks.  Emerging market shares have fallen similar amounts the Yen has strengthened 8% at its best, but is now weakening with a little help from the Bank of Japan. Equity markets everywhere have performed poorly across the globe. Emerging market currencies such as the Rand have fallen nearly 20% since the beginning of the year.

South African non-precious metal stocks are among the most battered in the world, outpaced in the quarter-to-date only by those in Colombia, Turkey, India and Egypt.  South African stocks are down 33% in $ terms and 24% in Rand terms, from their peak.

But gold and gold shares in particular, many feel, are earning their reputation as no place for widows and orphans. Is that really fair, we ask? We would point to the circumstances in which this volatility occurs. Please note the following: -

• Gold has fallen 25% after a rise of 35%.

• The €, in the last couple of months has risen 10% since the beginning of the year.   Further rises are on the cards, when € interest rates rise and if U.S. interest rates do not rise. [We are prepared for one more 0.25% hike in the U.S. Fed Funds rate.

• The $ is being talked down everywhere, with the least commentators expect is an ‘orderly’ decline. Global economic tensions have risen sharply and threaten much higher oil prices and general ruptures in several facets of the global economy.

In other words, it is not just the precious metal markets where volatility is found and expressed in prices.  Volatility becomes the common denominator of many different and global markets. However, it is the precious metals markets that rise during volatile times. Investors turn to precious metals when they fear poor performances in other markets as a result of uncertainty and volatility in those markets. Hence the term “Safe Havens”.  

All of us are shaken by volatility and hope to avoid it, but these days it is becoming unavoidable and promises to worsen. Against that scene we are seeing a growth in defensive optimism, such as, “interest rates rises will end the gold price rise” and “inflation fighting will see the end of metals price rises”. It is a normal reaction to search for the positive to counter the negative, but it often reaches into the realm of the unreasonable.  In doing so it clouds the picture and gives credibility to any story that pops up. Defensive optimism is part of this. The principle underlying defensive optimism is that if you say something often enough and with conviction most people will believe you, even if reason says you shouldn’t. To avoid being sucked in by such optimism, one only has to keep one’s eye on the underlying factors that drive these markets.

The net effect of both defensive optimism and globally rising interest rates is first, a withdrawal of investments from the emerging markets, including gold shares. With the fall in exchange rates of emerging countries including South Africa, gold mining shares should be proving more attractive.

We do not believe that the raising of interest rates will end the gold bull market but simply provide a buying opportunity in precious metal shares across the board. However, we do believe that the markets will then understand that the gold price average is rising sharply even after the present pullback in prices. In doing so we expect gold shares to rise far more than in the last run. The same will prove true of silver mine shares, even more so!  We expect both types to outperform the underlying metal in the next upward move as a result.  If one looks back at the gold share performances you will see they ran out of steam well before the gold price itself did. The next time round should prove different and particularly when quarterly results prove the benefits.

To bring perspective to what we have said we ask you to consider the results of our own portfolio below.  We bought these gold shares mainly a year ago, as markets equity markets gave rise to concern, but added some along the way,  because of our “Trailing Stop” policy, we sold out the portfolio around 5% from the top of the peak.

Just compare this performance with that of the equity markets across the globe as all experienced volatility.

As you can see then, a comparison of this volatile market to other volatile markets in these volatile times shows that precious metal shares are the place to be, if only to protect the wealth one has already gained.

© 2006 Julian D. W. Phillips
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