Monday, October 8, 2012

Not all “gold” is born equal. Gold and the Dow Theory.



Gold? What kind of gold?

 
Followers of this “Dow Theory Investment” blog know that I always keep a very close eye to gold and silver. This is something that is not very usual in the investment fraternity, since gold tends to be disparaged, at worst, or ignored, at best. This accounts for making gold only 1% of the average portfolio.

Well, maybe I am like Don Quixote always ready to defend hopeless causes. Perhaps this is what prompted to create this Dow Theory blog as a bastion of independence to set the record straight about the Dow Theory.

Going back to gold, the investor should know the “animal” he is dealing with, since not all that passes for gold is created equal. I’d say gold comes in many flavors. You must know the pros and cons of every flavor.

Gold, all the critics notwithstanding, is a very important asset. Extolling the virtues of gold and why it should definitely belong to the investor’s portfolio is the subject for a book. Those really interested in understanding gold, should go to Fofoa's blog, which you can find here, and read all his posts. The greatness of Fofoa is that he is not a gold bug but by being rigorous in his analysis, he makes a very compelling case about the virtues of gold and its vital geopolitical role. No need to resort to conspiracy theories, no need to bash JP Morgan, just plain analysis. Fofoa, IMHO, is one of those rare instances of really good “fundamentals." However, understanding Fofoa has many angles, and it takes lots of time to finally “get it." The reward, if Fofoa is proven right in his analysis, is beyond what the most ardent gold bug may expect.
 
Of course, Fofoa’s analysis, as with any good fundamental analysis, belongs in the very long term. I’d say that Fofoa’s insights may take from two years to 20 years to play out.

If you believe in gold based on the fundamentals of the economy, the monetary system, etc., then it must be physical, allocated, and preferably outside the banking system (it is never enough when it comes to protecting your gold), and you cannot and should not trade in and out of it.

One of the tenets of Fofoa is there is only one kind of “real” gold. That is physical gold in your possession. He strongly warns the reader about holding securitized gold like GLD. And he’s right. If the long term scenario predicted by Fofoa plays out, the only gold that will really shine is physical unambiguous gold in your possession (or very close to it by storing it in an approved vault).

If one is to make a gold commitment for the very long term, one has essentially bought "insurance" against many unknowns. If gold is to be hold for the long pull, then I feel that it should be physical because the very reason of such gold is to protect you against the implosion of the financial markets, war, etc. or as Fofoa says, gold becoming the “Reference Point” (instead of the USD). Under such scenario, I'd prefer to have physical unambiguous gold than a share representing gold entangled in the financial system. Furthermore, gold held as coins has no storage costs and, for those investing in size, gold bullion can be safely stored for ca. 0.2% annual fee, which is cheaper than holding GLD (in which case you have to pay an expense ratio of ca. 0.40% annual + depositary fees if you want the shares to be registered in your name instead of "the street's"). So for the long-term investor storage in a certified vault is cheaper in the long run and safer. If goes without saying that I'm talking about fully "allocated" gold. Forget precious metals accounts if you are really serious about holding physical gold.

Of course, gold in a vault is not supposed to be traded; not even under the Dow Theory. Gold in a vault, I insist, represents a very long term, and probably, a life commitment.

However, in shorter time frames (let’s say 1-2 years), holding physical gold is inconvenient as it does not lend itself well to quick and inexpensive buys and sells. Here is where GLD or similar ETFs (provided, they have sufficient liquidity).

Furthermore, the shorter and more technically oriented time frame in gold also plays a legitimate role for the active investor. And here is where the Dow Theory glitters together with gold. In a 1-2-year time frame, the Dow Theory may help us be on the right side of the gold market and, hence, fully enjoy the best gold has to offer (great diversification and a very significant fundamentally based upside potential) while avoiding the worst (vicious pullbacks or the risk, as it happened in 1980 of being left holding the hot potato in your hands). As we know, the Dow Theory by punctually signaling a bear market will keep investors protected.

 Furthermore, for those of a strictly technical penchant, gold is in a primary bull market under Dow Theory, as you can read in my post "August 22, 2012. Dow Theory signals a new primary bull movement in gold and silver", which you can read here.

This means that it is likely that the upward movement may last 1-2 more years and witness a price gain exceeding 40%. All this according to the empirical track record because we are dealing with odds not certainties. 

Therefore, I see GLD for those with a shorter time frame, let's say less than two years, just seeking to make "paper" gains but uninterested in the long term "insurance" role of physical gold. Those investors should be aware that they are trading a financial instrument and that if Armageddon occurs (something the markets are not suggesting right now, by the way) your paper securitized gold will not help you out.

So GLD is good for traders or short term investors. But “caveat emptor” you have to know the beast you are dealing with and what your objectives are.

Sincerely,

The Dow Theorist.

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