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August 01, 2009 at 04:00 AM
Frank Holmes
U.S. Global Investors
800-873-8637
[email protected]
Conditions have improved for gold equities, and economic policy decisions being made in Washington could further increase the investment appeal of these mining stocks. Look at the relationship between gold-mining stocks and the federal budget … since 1971, when President Nixon ended dollar convertibility into gold and deregulated the price of gold.
When the federal government is spending more than it takes in, gold stocks tend to outperform the broader market. One hundred dollars invested in the S&P 500 at the start of 1971 underperformed the gold-stock index essentially for a quarter-century. In each of these years, the federal government engaged in deficit spending. The S&P 500 surpassed the gold-stocks in 1997, in the midst of the tech boom and budget surpluses under President Clinton.
When those surpluses reverted to widening deficits after the Sept. 11 attacks, the spread between the broad market and gold equities was narrowing. At the same time, another important event occurred — China began to deregulate its precious metals markets. During that period, the S&P 500 dropped before largely leveling off, while gold stocks charged forward.
Gold stocks have delivered a 9.9 percent average annual return since 1971, while the S&P 500′s annualized return has been 9.6 percent. That $100 invested in gold stocks in 1971 would have grown to nearly $3,800 at the end of May 2009, while the same amount in the S&P 500 Index would be worth about $3,400.
So now that we’ve established the relationship between gold stocks and the federal budget, let’s look at the current situation. The federal government, which has spent huge amounts to save the banks and stimulate the domestic economy, is expected to see a $1.8 trillion gap between revenue and expenditure.
If the federal budget projections are accurate, we can expect massive deficits to continue, which will likely fan inflation fears and keep downward pressure on the dollar. These large deficits, combined with China’s growing appetite for gold, create the potential for gold stocks to remain an attractive investment relative to the broader market for some time to come.
