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Why Gold Stocks Failed (And Why I'm Still Holding On)

by: The Society October 15, 2008 | about stocks: GDX / GLD    

The Sovereign Society

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By Eric Roseman

Since the start of the credit crisis in August 2007, the XAU Gold & Silver Index of mostly large-cap mining stocks has tumbled 27%. In October alone - the worst month for investors in global stocks since August 1998 - the XAU Index has so far tanked 20%.

Gold bullion, however, has gained a cumulative 26% since the outbreak of credit panic in August 2007. As the rest of the markets have crashed this month, gold has only declined 2%.

Gold stocks are another story. They have failed miserably so far this year. They're failing despite the fact that mine production will remain flat in 2008. Not to mention, demand is booming among nervous investors who are searching for a safe haven. Also, European private banks have to wait almost three weeks to fill orders for clients - there's barely any net gold supply.

What ever happened to gold stocks protecting portfolios during a market crash? Why have gold stocks disconnected from gold bullion lately?

On occasion, gold and gold stocks can deviate from each other. This is why you always should hold both physical gold (bars, coins, certificates) AND gold mining stocks as part of your precious metals strategy.

Historically, this happens during extreme market circumstances. For instance in late 1979, gold stocks collapsed while gold bullion climbed to US$850 an ounce by January 1980.

The same phenomenon took place over the last 12 months. Gold stocks have been absolutely mauled while physical gold has rallied. Gold stocks are now trading at a seven-year high compared to the physical metal judging by the gold-to-XAU Index ratio. That means gold stocks are absurdly cheap compared to the metal itself.

This is the time to hold both gold and the precious metal stocks, including silver.

The ongoing shift from a world obsessed with rising inflation has peaked since July. The major focus now is accelerated deflation, or an environment of rapidly declining asset values. This is the first time since the 1930s that prices worldwide are simultaneously falling together - stocks, bonds (non-government), real estate, hedge funds and other financial assets.

In a deflation, gold should hold its value. But anything traded on the stock market is unlikely to rise in value as the Wall Street tidal wave sinks all ships.

And to make it worse investors have thrown out the gold stocks in their scramble for liquidity. Since last Wednesday, they have even started to sell Treasury bonds to meet liquidity provisions or margin calls.

Eventually, the world will reflate again. Budget deficit targets in Europe will be smashed, the United States will expand credit like a monster. And in time, inflation will make a big comeback - a far more serious comeback than what we've seen so far.

I expect gold stocks to probably double from these bombed-out levels over the next 12-36 months. Prices are extremely low.

As a fellow gold-bug, I feel your pain but I urge you to remain steadfast in your gold positions. The enormous cost of this now global bailout will continue to rise. As it does, gold will continue to rise in value.

Be patient with gold and the gold stocks. Salvation is coming.

Disclosure: none

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This article has 12 comments:

  •  
    Oct 15 07:22 PM
    I'm not impressed with gold stocks. Always a problem. They are risky. They are stocks.

    They move with the market. It is not safe.

    So hang on to your shorts in this environment!
    Reply
  •  
    Oct 15 07:34 PM
    So why have gold stocks failed....I don't see anything attempting to answer that in this article.
    Reply
  •  
    Oct 15 09:52 PM
    You say ``In a deflation, gold should hold its value``. Where did you get that idea? In a deflation, prices of everything drop. The only thing that goes up is the value of cash.

    Maybe it`s because the commodity is less liquid than the shares and can be artificially supported by `people` (to put it politely) like you.
    Reply
  •  
    Oct 16 08:37 AM
    Gold holding is value in times of deflation does not mean it will hold its price, just at it doesn't hold its price during times of inflation. However, at whatever price it is - higher during inflation, lower during deflation - it will eventually find its historical value against the rest of the economy. Therefore, if 500 ounces will buy a$400,000 house at a gold price of $800/oz it will still buy that same house (now a $200,000 house) with with 500 ounces of gold at $400/oz.. This is what is meant by saying that gold will hold its value.

    I know there is manipulation of the COMEX gold price, but it could be one reason that gold is not responding to all the money pumped into the economy is that we actually are experiencing deflation. We certainly are seeing deflation in the stock market; the drop in price is certainly much greater than can be accounted for by the drop in business or even the expected drop in business during a recession.
    Reply
  •  
    Oct 16 02:16 PM
    It makes no sense that gold producers (unless they are hedging) whose product is gold have sold off over 50/60% compared to physical gold - does this signal that gold will fall to $400? I dont think so. So WTF is going on?
    Reply
  •  
    Oct 16 02:59 PM
    Don't miners make their profit on the margin of market price above their cost of production? If so, small moves up or down in the market price will have a more dramatic effect on miner's profit. Theri stocks reflect their earnings potential - not just their production volume.
    Reply
  •  
    Oct 16 03:34 PM
    During the great depression ,gold increased in value and CASH WAS NOT KING .
    Reply
  •  
    Oct 16 03:38 PM
    But Gold hasnt fallen that much relative to the producers so margins havnt been squeezed! If Gold had fallen then your observation is of course correct - maybe the producers are discounting the relationship between Gold and Oil. However if oil falls to $50 as GS suggests (an amazing turnaround from $200 in a 4 month time period - must be an Abbey Joseph Cohen type "analyst") and Gold HASNT decoupled from Oil then Gold will fall to say $400. The answer is IMHO that stock portfolio liquidations are throwing the (producer) babies out with the bathwater
    Reply
  •  
    Oct 16 06:51 PM
    Cash out everywhere and start buying real state, there is a lot of bargains out there and it is the only safe investment other than having the money under your mattress, you don't wanna hold your cash in the bank nor is there a safe investment at the moment. Gold became just ahother asset class and you won't even be able to sell off in a panicky market, real state cannot be taken away it is as solid as having the cash in your pocket and historically prices have always rebounded over time in a shorter timeframe than commodities, prices may drop another 10% to 15% in the next 6 months but once inventories start to decrease, markets stabilize and America gets used to spend in an budget (like you one should have been doing for the last 4 years) then you'll get a good return, you would've had your money safer than in a bank, you would've had slept nicely and your cash had been in a hard, uncheatable asset (you can even live in your investement if you wanted to). Not even treasuries are safe at the moment, not because there is a risk of USA not honoring them but because like all those bubbles it is about to burst badly.
    Reply
  •  
    Oct 16 06:56 PM
    By the way, helping stabilize the housing market by buying it at ridiculous prices not only will make you money but you'll become an active player in helping the economy get back on its feet, that's is patriotic, remarkably patriotic and very profitable long term, buy urban hot areas and you'll be just fine. I was right shorting Gold and I deeply believe I'm right on the real state bet, I hate not to have the money to do the real state thing myself.
    Reply
  •  
    Oct 16 07:13 PM
    I have GLD, GDX & SLV. They are ALL 3 dropping like rocks.
    Reply
  •  
    Oct 16 07:15 PM
    I have GLD, GDX & SLV. All 3 are dropping like rocks.
    Reply
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