Precious Metal

The recent pullback from gold “let some air out of the balloon,” says Pursche, and has resulted in a more realistic and measured approach toward it by investors. Of course, since that pullback, the price of gold has once again climbed, but Pursche expects that the rise will be more measured going forward, especially since many feel the global situation is not as precarious as it was.

But while investors may not be so fearful of an out-and-out systemic collapse, whatever concerns they have now are just as legitimate, particularly with respect to inflation, which many believe will be the strongest driver of gold prices going forward.

With central banks across the globe maintaining interest rates at low levels, the threat of inflation around the world is high, Land says, and this makes gold more attractive.

“If we do have inflation, there will be more printing of dollars and euros, and at the same time, we don’t see a huge amount of [gold] mine supply coming,” he says. “If we have inflation that results in, say, 15% money growth and gold is only growing at 2%, then its value is going to appreciate relative to paper currency.”

Gold as a replacement for money has been an ongoing trend over the past few years and is set to become stronger in an inflationary environment, agrees Fred Sturm, who manages the Ivy Global Natural Resources Fund (IGNAX) for Waddell & Reed Ivy Investment Company. “As the stock of currency rises, the demand for gold has upward pressure, and this basically speaks to gold as a replacement for the debasement of money,” he says. “We expect that monetary policy around the world will have an embedded inflation upside and the printing of money will continue, so we expect the upward trend in gold to continue.”

The price of gold fell as the fear of a collapse of the banking system and a financial market meltdown became less pronounced, but now, with inflation looming on the horizon, gold once again has the potential to rise, agrees Nathan Rowader, Forward Management’s director of investments and lead manager of the Forward Commodity Long/Short Strategy Fund (FCOMX).

“Gold is not such a great investment in a period of low inflation, but now we’re stuck in an environment where everyone is looking at Europe to take action on the issues that plague it, and when Europe does, inflation will rise, so people will buy gold to hedge currencies,” he says.

Gold allows for diversification away from the U.S. dollar, Land says, a move that many think is a good one to make in these times. Gold, he says, also has a very low correlation to major indices, so it provides great diversification opportunities.

The only thing that could crush the gold bug going forward would be “a central bank with a fly swatter,” says Sturm, one that would raise real interest rates to 2%. But given all that’s going on in the world, and the fact that central banks have been net buyers of gold as opposed to sellers, “we simply do not expect that that will happen within the next several years,” he says.

And From Whence Comes the Gold

The demand for gold has been huge, but what about the supply of gold?

According to Gissen, the supply side of the gold story has been largely ignored thus far, but it has the potential to become more interesting to investors going forward when they realize how undervalued gold mining equities actually are.

“Because people, out of fear, wanted to invest in an asset that is durable, they poured their money into gold ETFs, but not into the mining companies, and they are now seriously undervalued,” Gissen says. “But because of the strong demand for gold, many mining companies are sitting on piles of cash. Yet people are not aware of this because their fear led them to invest in the commodity.”

It is much easier to invest in a gold ETF, Gissen says, because it takes time and decisiveness to decide what gold company to invest in. However, companies like Canada’s Avion Gold and Extorre Gold Mines, an emerging gold and silver producer in Argentina, are companies with great potential that are worth looking at because they have solid cash reserves and their stocks are, at present, seriously undervalued.

There is little doubt that there is a big disconnect between gold, which is up 20%, and most gold equities, which are down, says Land. But for investors to consider those stocks as an investment alternative that forms a part of the overall gold story, they need to judge them for their ability to create wealth over time, not least because mining companies have historically not been the greatest of performers.

“Prior to 2005, they generated very little free cash, and there is 40 years worth of data to show that this is a value-destroying industry,” Land says. “It is only now that we have seen margins starting to open up. With gold prices at $1,700 an ounce and the cost—including the cost to replace and extract—well below $1,000 an ounce, you are indeed looking at companies with very good prospects, and investors do not really understand this yet.”

Like many resource sectors, gold mining companies can only create wealth by finding gold, and to the extent that companies have been successful in making discoveries, their shares have been rewarded, says Sturm. Companies like South Africa’s Rand Gold have done well in terms of exploring and developing, and its share price has actually outperformed the gold bullion price, he says.

“But it is only recently that the gold price has advanced enough for profit margins to have improved substantially for major mining companies. In this backdrop, well-run companies with a deep resource base will indeed generate handsome profit margins and that will, in turn, make them attractive as investments.”

If investors put their money into gold mining stocks, they could fare very well indeed, says Gissen.

“At this point, if the price of gold goes up, it will only go up by about 30% or so, but if you invest in any of the gold mining companies that are undervalued and they have a good year, they could double or even triple in value and keep going from there,” he says. “We bought gold equities at $3 and now we see those stocks trading in the $20 range. In addition to investing in the gold itself, investors now need to look at who is actually getting them the gold.”