Gold: Commodity, Investment… and a Currency

As I often say, gold is a chameleon. It changes in response to the environment.

At times, gold behaves like a commodity. The gold price tracks the ups and downs of commodity indexes.

At other times, gold is viewed as a safe-haven investment. It competes with stocks and bonds for investor attention.

And on occasion, gold assumes its role as the most stable long-term form of money the world has ever known.

Right now, gold is behaving more like money than a commodity or an investment. It is competing with central bank fiat — that is, paper — money for asset allocations by global investors.

We know this because gold’s price action has diverged from the price action of other commodities.

This divergence first appeared in late 2014 but has become more pronounced in recent months.

Gold observers know that gold measured in dollars is down significantly from its all-time high in 2011. Comex gold peaked at $1,876 per ounce on Sept. 2, 2011, but traded as low as $1,056 per ounce on Nov. 27, 2015. That’s a 44% decline in just over four years. Yet in the same time period, broad-based commodities indexes fell even more. One major commodities index fell 53%.

The contrast between the behaviour of gold and commodities is even more extreme when we narrow the time period. From June 20, 2014, to Jan. 15, 2016, the broad-based commodity index fell 63%, while gold fell only 17%. The recent collapse in commodity prices was almost four times greater than the decline in gold prices.

From mid-January to mid-February 2016, gold rallied 14%, while commodities still languished near five-year lows.

Right now, as investors around the world are losing confidence in a long list of emerging-market currencies, investor preferences are shifting toward dollars and gold. This accounts for gold’s outperformance of the rest of the commodity complex when measured in dollars.

And when the price of gold is measured not in dollars but in rubles, yuan or rials, the percentage price increase in gold is even more impressive, because those currencies have all declined lately against the dollar.

When you understand that gold is money and competes with other forms of money in a jumble of cross rates with no anchor, you’ll understand why the whole monetary system is going wobbly.

A run to $10,000 an ounce

Lost confidence in fiat money starts slowly and then builds rapidly to a crescendo. The end result is panic buying of gold and a price super-spike. Why? Because gold doesn’t have a central bank and doesn’t have the associated risks. In addition, gold always inspires confidence, because it is scarce, is tested by time and has no credit risk. That’s why investors flock to gold during times of uncertainty.

We saw this behaviour in the late 1970s. Gold moved from $35 per ounce in August 1971 to $800 per ounce in January 1980. That’s a 2,200% gain in less than nine years.

Right now, we see global uncertainty coming from every angle. This means we may be looking at the early stages of a super spike that could take gold to $10,000 per ounce or higher.

So the time to buy gold is now. I recommend a 10% allocation of investible assets to physical gold and other precious metals for your permanent portfolio.

Another metal I think you should own is silver. Silver has many industrial applications. It’s also a true commodity and a form of money, like gold.

The price of silver may rise or fall based on industrial utilization and the business cycle, independent of monetary factors such as inflation, deflation and interest rates. Nevertheless, silver is a form of money (along with gold and dollars) and always has been.

Once you’ve taken care of the physical allocation, you can think of less-direct gold investments.

Many investors buy stock in the companies that mine silver and gold. (My expert Aussie gold analyst has a selection of Aussie gold stocks he likes now. Go here.)

Of course, every mining stock is different. In general, they all rise and fall in line with precious metals prices. But other factors come into play on an individual level, from the quality of its mines to the costs of doing business in whatever country or countries it operates in.

That’s why, aside from speculations, my expert Aussie gold analyst likes to look at precious metals companies that avoid the costs risks of mines almost entirely. These are a handful of firms that have developed an incredible business model that’s almost a license to print money.

In fact, when this idea got its start, it created what was practically a ‘renegade’ currency of its own.

These are companies that collect royalties from silver and gold.

From a small stream…

The idea behind all resource royalty companies is pretty simple.

Finding a new resource, building the production facility and then extracting the resource and bringing it to market is very expensive. To raise the necessary funds, a company can try to borrow from a bank — which, of course, must be paid back. Or it can offer investors a stake in the venture — which requires navigating legal and regulatory hurdles. Finally, it could turn to a royalty company.

The royalty company offers to pay an upfront fee to a mining company. In return, the royalty company gets a fixed percentage of the mine’s sales, a portion of what the mine produces, or the option to buy part of the mine’s production at a reduced price.

The roots of the idea can be found in America’s westward expansion, where individual claims to mineral deposits traded freely, becoming — in its own way — a form of currency. That naturally led to subdivision, where a person would promise a portion of the proceeds from the claim.

In fact, these royalty companies are almost exclusively unique to the US market.

The idea evolved and became formalized through legislation. By the early 1980s, mineral royalties were fairly common for oil and gas deposits. But surprisingly, they were rare for minerals like gold and silver. Royalty rights to gold and silver deposits were negotiated between one mining company and another. Ordinary investors had little way to participate in them.

One entrepreneurial businessman had made millions buying oil and gas royalties. He wondered if he could do the same things with gold royalties. So, with a couple of partners, they developed and launched a business plan.

The company is today listed on the US market, and is one of my Aussie gold stock analyst’s favourite ways to play gold. You can find out more details here.

To an ocean of profits

Today, there are several similar such companies deriving profits from mining without doing any of the dirty work themselves. In other words, theoretically, they have much lower financial risk than miners, because they don’t have the high costs of operating a mine.

Because of this, gold and silver royalty companies tend to have high profit margins. The only real costs are employing a front office and funding new royalty deals.

Of course, you can’t just buy any royalty company and expect profits to roll in. That’s why my gold stock analyst has put in many hours of time and effort into finding what he believes is the best gold royalty stock on the market.

All the best,

Jim Rickards,
Strategist, Strategic Intelligence

From the Port Phillip Publishing Library

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James G. Rickards is the editor of Strategic Intelligence, the newest newsletter from Fat Tail Investment Research. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. Jim also serves as Chief Economist for West Shore Group.

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