What’s so great about gold?

  • 21 Apr 2012
  • National Post - (Latest Edition)
  • Financial Post Peter Hodson, CFA, is CEO of 5i Research Inc., a conflictfree independent investment research network.
  • Whenever anyone dares to say something negative about gold, the bullion bugs and conspiracy theorists come out en masse.
  • "How dare anyone say anything negative about the yellow metal. Don’t you know that after governments print enough money to send us all into an inflationary oblivion it will soon be the only currency in town?”

    To them, we will grant that gold: a) is a great store of value; b) has gone up for 11 years in a row; c) can protect your portfolio in inflation; and, d) is a good asset to have in a portfolio.

    However, most worshippers of the golden idol never stop to consider the following about gold: a) it pays no interest; b) it actually costs you money to store; c) it can and does go down (remember the 20-year bear market in gold?); and, d) just when you need it the most, it often disappoints.

    To that latter point, gold didn’t exactly soar during the 2008 financial crisis. Its liquidity actually worked against it, because it was one of the only assets investors could sell.

    Don’t get us wrong: Gold is a great asset to own in a portfolio. We just think it needs to be within reason, say, 15% of your portfolio (most advisors would say 5%, so that proves we actually like it as an asset a lot).

    However, many investors go all-in on gold. These investors refuse to buy stocks, waiting for the hyperinflation payoff from gold. Warren Buffett, in a recent Fortune column, put it this way about gold: "This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce — it will remain lifeless forever — but rather by the belief that others will desire it even more avidly in the future.”

    The way Buffett puts it makes gold sound like a bubble at best, and a Ponzi scheme at worst. Keep in mind that he is the second-richest guy in the world.

    In Canada, we had to chuckle at a recent monthly letter from Venator Capital, headed up by Brandon Osten. He recently visited a gold mine site and came back with these comments. Note that Venator doesn’t own much gold, and has still managed a 19% return so far this year.

    So off we went to the mine’s facilities where we were greeted by two massive ‘tumblers’ that took already crushed rock and ground it into dust. The dust then went through a vat of cyanide to separate the gold from the ore, and then another vat of carbon solution to separate the gold from the cyanide. At this point the gold is ready to be poured into a brick the size of, well ... a brick.

    "Unfortunately,” he continues, "we didn’t get to see an actual brick of gold being poured. As it turns out, miles of underground caverns, acres of clear-cut forest, two massive rock tumblers, vats of chemicals, and hundreds of millions of invested dollars doesn’t quite get you to one gold brick per day in an industry where if you can pull a marble sized amount of gold out of a house sized chunk of ore, you have a pretty decent grade mine.”

    The skeptic in Osten points out that this is an outrageous amount of effort for what is, from a practical standpoint, a near useless metal that, due to the advent of electronic asset storage has outlived its usefulness in human society. Although not, he allows, to the financial services community, which will "trade derivatives on it until the end of history.”

    Keep these smart managers’ comments in mind the next time you are tempted to increase your gold holdings. Yes, it is valuable. Yes, gold can go up. It can diversify your portfolio and reduce risk. Like any asset, though, it is only good if someone else wants it in the future. Like life, maintain some balance in your portfolio.