Is this the king of gold stocks?
Stock summary: past outperformance to gold with rising dividends
The following is for educational and informational purposes only, and is not a recommendation to buy or sell shares. When buying or selling shares, investors should do their own research and seek independent financial advice if necessary.
In this summary:
Reasons to have gold exposure in a portfolio
The many ways to have gold exposure in a portfolio
Possibly the best way to get gold exposure? (But little known.)
A gold stock that has outperformed gold in the past, and with a long track record of increased dividends every year.
Housekeeping: in case your email system clips this message, you can find the full analysis at this link.
The major quandary facing all investors is what to own. And the first question to ask is how much to allocate to each asset class. This is something that I'm constantly asking myself, even if I don't make huge changes very often.
The main asset classes include:
listed stocks & shares (equities: tradable ownership stakes in companies)
bonds (tradable debt securities)
cash deposits & money market funds
gold and other precious metals
real estate
industrial and agricultural commodities
"alternative assets" such as private equity or hedge funds
financial derivatives such as options and futures
"structured products" (packaged derivatives)
collectibles (such as art, antiques, rare coins, fine wine, classic cars, etc.)
I believe - especially when it comes to any patient, long-term investor - that the core bulk of any portfolio should consist of stocks.
Both from a theoretical perspective, and evidenced by the long historical record, this asset class is likely to deliver the highest returns. That's when taking account of capital gains and cash dividend income.
The secondary challenge is choosing which stocks or stock indices to own. My investment book aims to provide a lot of guidance in this regard, as well as the pros and cons of all the asset classes. (I'm a bit behind on the chapters, but much more will be coming soon.)
That said, there can be good reasons to invest in other things at times, such as bonds, or real estate, or holding more cash than normal. However, for the most part, I believe that private investors shouldn't park much capital in commodities (there are exceptions). Meanwhile, alternative assets, derivatives and structured products are almost always best avoided.
As for collectibles, which don't generate a cash income and generally require a lot of specialist knowledge, they're best owned for their enjoyment, and not as a serious way to make money.
(I have limited experience of this in the area from owning a classic sports car from the 1960s for about seven years. It doubled in price, which seems like a great return. But after taking account of all costs and sales taxes I reckoned that I roughly broke even. Still, it was a lot of fun for me and my Dad, for just the opportunity cost of the capital invested. Much cheaper than buying a brand new and fast-depreciating sports car!)
One other thing that I believe always has place in any portfolio, alongside stocks and cash deposits, is exposure to gold. The only questions are how much and how to gain exposure.
Gold investments are worth having for multiple reasons:
Portfolio diversification: the gold price has a low correlation to general stock market moves, and often moves in the opposite direction (negative correlation), especially during stock market crashes.
Physical gold (coins and bullion bars): it's no one else's liability, and can be held in physical form outside the financial system.
Inflation protection: over the long run, gold has preserved it's real value (purchasing power). This is certainly better than cash notes, or even a lot of bonds over very long periods (e.g. the bond bear market from the 1940s to 1980s).
Rising demand combined with finite supply: As the vast emerging markets, such as India and China, get wealthier over time this means more people can afford gold jewellery (the main end use of gold). At the same time, gold mining is becoming more difficult and expensive over the long run, as reserves are depleted.
Crisis insurance: Investors flock to this well-known store of wealth when financial crises strike and currencies, bonds, stocks and real estate prices all collapse.
Recently I outlined my concerns about the dreadful financial condition of the US and most other developed countries, and why things are likely to get worse. (You can read it here - free to all subscribers.)
What's more, there is a decent probability that the gold price will take another leg up later this year, as central banks start reducing policy interest rates. This is because owning gold has an opportunity cost, in that gold doesn't generate an income, unlike bank interest, bond coupons and share dividends. Capital invested in gold could be earning a cash yield elsewhere.
In broad terms, when interest rates and other income yields rise that is likely to weigh on the price of gold. Conversely, when rates and yields fall, the opportunity cost of the lost income from gold ownership - compared with holding alternatives - is reduced. This provides a boost to the gold price. (This is all other things being equal. There may be other factors working in the opposite direction.)
Overall, I believe there is certainly a good case for having gold exposure over the long run, across years and decades. Plus the current macro set-up could also lift the gold price in the short run, over the coming months or a year or two. Although that's never certain.
Ways to own gold, and how much of it
For investors that agree that it's a good idea to have gold exposure, the next decisions revolve around how much and what to own.
In terms of how much, for most people this should probably lie somewhere between 5% and 25% of a portfolio.
That said, as the world entered the global financial crisis of 2007 to 2010, I personally went as high as 50% gold allocation, with most of the rest in cash deposits (spread across several accounts, given the uncertainties at the time). But that was an outlier situation, where my primary concern was to avoid financial wipe-out until the air cleared.
In terms of how to get gold exposure, there are many ways. Here are some of the main ones:
Physical gold coins (usually one ounce or one half ounce), small bars (e.g. 100 grammes) or allocated bullion bars (owned in whole or in part), that are your direct personal property. (Although the bars are likely to be stored in secure vault somewhere. See bullionvault.com for one company with a good track record and reasonable fees, in my opinion.)
Gold-backed funds (ETFs or ETCs) that trade like stocks. These are a convenient way to get exposure to gold price moves via a brokerage or pension account.
Gold mining stocks or funds of such stocks. Gold mining profits have operating leverage, meaning that the bottom line profits are more changeable than the top line revenues, due to the relatively fixed costs of mine production. As a result, the stock prices will tend to be more volatile than gold itself. If gold goes up, they will tend to go up more, and vice versa (at least in the short run).
Gold certificates, such as those issued by the Perth Mint in Australia.
Gold grains and other non-standard sizes of physical gold.
Gold derivatives such as options, which are short-term bets with highly volatile prices, and thus one of the riskiest ways to get exposure to gold.
Physical gold and gold-backed funds will perform in line with the gold price (less any associated fees). Therefore they are the least risky, and should probably form the bulk of any allocation, especially if it's a large allocation (say 20%+).
Certificates, grains and derivatives aren't worth the bother in my opinion. Each has its own drawbacks. There are better choices.
Gold mining stocks offer a way to get leveraged exposure to the gold price. The prices are more volatile than gold itself, but not as risky as gold options (which can, and frequently do, expire worthless for a 100% loss).
So gold miners are useful for investors that want to add some extra upside potential to their core gold holdings, or for investors that want to commit less capital to their gold exposure (say 5-10% of a portfolio), but still want meaningful upside if gold takes off in future.
But there's another gold alternative that I haven't mentioned yet. It's a kind of halfway house between physical gold and gold miners. It still has some leverage built in, but with more modest risk than mining companies.
What's more, it provides modest but growing dividend income along the way.
Furthermore, over the long-run at least, it has outperformed both gold and gold miners by a meaningful margin. For anyone planning to be a long-term gold investor, this can make a major difference to the eventual outcome.
The rest of this report (exclusively for paid subscribers to OfWealth - you can sign up here) will take a look at this lesser-known way to get gold exposure, why it tends to deliver superior returns, and summarise the stock with the longest track record of success.