Why Gold is Out, Especially the Miners

Gold MinersI’m a frequent critic of gold (GLD) in an investment portfolio. Seeing as it doesn’t generate income, doesn’t grow, and costs money to store, it’s a highly-speculative investment. That doesn’t mean it isn’t without its good years – those who bought gold ETFs in 2004 have doubled their money.

 

Gold is Losing its Luster

Panics tend to send investors to some interesting investments, gold and other precious metals included. I remember article after article in 2008-2009 voicing the opinion that investors should keep at least 5-10% of their portfolios in metals. Where were these articles when gold was under $400?!

As the economy improves, investors leave their bomb shelter portfolios. Naturally, gold has sold off, falling from a peak in the $1800s in 2011 to the $1300s.

Investors once again realize that gold has few upsides:

  • It costs money to store, which makes it a negative carry asset.
  • Gold doesn’t yield anything, unlike other bomb shelter assets like farmland.
  • It’s prone to rapidly changing price fluctuations.
  • As rates rise, the opportunity cost of holding precious metals becomes more apparent.

As gold tumbles, some are calling for a play in gold miners. Some even label it one of the most beaten down sectors on the market. In an ideal world, higher gold prices should beget larger profits for gold mining companies.

 

Here’s Why Mining is Even Worse than Gold

Mark Twain once said that a gold mine is “a hole in the ground with a liar on top.” No one has ever summarized the business so perfectly.

Gold mining is a notoriously tough business. Not only are miners exposed to quick changes in the price of precious metals, but they’re also exposed to rising operational costs. When metal prices are high, labor, energy prices, and equipment prices generally follow. Remember when mining jobs quickly became the new thing? Salaries topped $100,000 for rookie positions.

All the while gold prices ran to nearly $1,900 an ounce, gold mining stocks failed to deliver. Gold miners actually lagged the change in gold prices, despite the fact that miners are supposed to be levered to the price of gold.

Their shares should rise and fall faster than the price of the metal since a change in price results in a lager change in profits and losses. That’s a perfect world. When gold goes up in price, so do the costs of bringing it to the ground.

 

It’s Time to Sell Metals

History is full of great times to buy gold; when it’s “cheap” it’s cheap. When it’s expensive, it doesn’t stay expensive for very long. Thus, there are only a few good times to sell gold, and plenty of time to buy.

I think gold is an excellent investment for 1% of your portfolio if you are a net seller of assets and not a net buyer. If you have a $10 million net worth, a little bit of gold and silver certainly doesn’t hurt in the off chance that those who wear a tin foil hat are right in their predictions about the future. For everyone else, however, gold makes little sense for investment purposes.

If you still have a significant investment in gold, dump it. At $1,300 and change, you’re not selling at the top. But you’re not selling at a low, either.

If you own miners, you’re doing yourself an especially large disservice, and you should run for the hills. Long term mining investors are rarely rewarded.

In the 10 years to 2011, the 10 largest gold miners generated $68 billion in operating cash flow, but they spent $89 billion on acquisitions and capital investments. Oh, and share count rose by 151% during the period, according to the Wall Street Journal. It doesn’t get much worse than that. Shareholders financed a remarkable amount of activity that produced negative cash flow.  Think gold streaming companies – another one you should worry about.

Now that gold is “out” it’s time to start rethinking why you own it in the first place. Should rates rise, the economy improve, and the budget deficit shrink, the current exodus from gold will look only like a tiny sell off ahead of a huge cliff.

Are you in or out when it comes to gold or other metals?

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Comments

  1. says

    I have never been a fan of gold. To some extent, it reminds me of the doomsday approach to investing because I had a boss many years ago who took that position. He invested heavily early and watched it go to $800 and drop.

  2. says

    We do not have gold as part of our investment portfolio. But we have gold, physical gold. In India it is traditional to give gold (mostly as jewelry, recently my parents started giving coins seeing I am not touching any of the jewels) for any occasion – marriage, baby shower, holiday gifts, etc. I have never calculated how much we have as I never even brought any of that with me to the US, it is in a safe deposit box with my in-laws. If I have to guesstimate a value, we probably have 10% of our portfolio as gold unfortunately. We don’t plan on selling it anytime soon though.

  3. says

    I’ve never bought gold. The closest I come to having an investment in precious metals is a couple of silver dimes I’ve gotten as change and set aside.

  4. says

    I love it. At parties I have to hold in the eye rolls as the inevitable gold lovers reveal themselves.

    In our asset allocations for larger clients, backtesting showed that a 5% allocation in precious metals wasn’t a bad call, however. The volatility often was so different than that of other positions that it mellowed a portfolio considerably. It was like a little dash of jalapeno that made all the difference in the recipe….

  5. says

    Mark Twain also said, “never trust a Mark Twain quote on the Internet”. Or something like that – I’m paraphrasing.

    I’m with you. I’ll probably be the idiot who runs the exact numbers, but I think gold is more likely to cover you in a deflationary era than help you in an inflationary one. No conspiracy theories here – I don’t think gold (the metal) or gold (the stock) is a genius idea currently, but I’d lean stock if I had to choose.

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