Gold has been considered for centuries the “ultimate store of value”. In a world where the governments of developed countries, as well as their central bankers, have become increasingly adept at guiding their economies through sometimes even the most turbulent economic and financial storms, gold’s role as the “ultimate hedge” against financial calamities has increasingly become a historical curiosity rather than something that affects the decisions of many of today’s investors. The exceptions are die-hard gold fans, including some who still yearn for a return to some kind of international gold standard under which all currencies are pegged or backed by gold.
In recent years, however, it is true that gold has had something of a resurgence. This was partly due to the growing demand for gold jewelry in developing countries such as India and, more recently, China, but also partly due to geopolitical instability that has generated uncertainties of a more complex and fluid nature than those that governed the cold war years with their geopolitical stalemate between the two superpowers based on the terrifying, if ironically stabilizing, fear of mutually assured destruction. There is also some evidence that the recent formation and purchases of physical gold by gold-linked exchange-traded funds (ETFs) have also helped stimulate demand for gold.
Direct investments in gold can be made by purchasing bullion, coins, jewelry and other physical forms of the precious metal, but for all but the smallest amounts, this brings with it the inconvenience and risk of storage and security. For the investor or trader, shares of gold mining companies provide a great way to take a speculative or hedged position on future movements in the price of gold. Stocks such as Newmont Mining (NEM), Barrick Gold (ABX), Agnico-Eagle Mines (AEM) or Goldcorp (GG) are listed on the New York Stock Exchange. (However, the last three are Canadian-based companies.)
While gold mining stocks represent shares in corporations, and therefore their individual price movements reflect news that is specific to the individual company, as a group, their share prices generally closely track the price of gold. Gold mining companies’ production costs are fixed, so any increase in the price of gold is reflected in the bottom line, and profits are similarly negatively affected by any drop in the price of gold. A rising gold price is a harbinger of inflationary pressures and therefore gold and gold mining company stocks tend to rise when stocks in general are under pressure and fall when the stock market is generally up on the day.
A purer form of gold (and indeed precious metals) investing/trading game that is not well known to many US based investors is Central Fund of Canada, which is listed on the Toronto Stock Exchange and under the symbol CEF on the US Stock Exchange. Central Fund of Canada, based in Calgary, Alberta, is not involved in any type of mining operations. It is a privately held investment management company created in 1961 to passively hold gold and silver bullion safely. At least 90% of CEF’s assets are held in gold and silver. An investment in the Central Fund of Canada provides ownership of shares in this gold and silver bullion, the value of which, together with certain holdings of cash and other assets, was as of August 31, 2007, just under $950 million (US dollars). As of that date, the split in precious metal holdings was 52% of net gold assets and 46% of net silver assets.
It should be noted that silver has somewhat higher volatility than gold, largely due to the fact that it has fewer commercial and industrial applications, as well as not having the same status as an “ultimate store of value.” Therefore, for a trading position, the element of silver serves to “drive” the position. For an investor, on the other hand, the Central Fund of Canada may still be targeted as a way to take a speculative position in gold specifically, as well as precious metals in general. This is because, over time, the correlation between the price of gold and that of silver tends to follow a set pattern. Recently this has been around 60:1, with an ounce of gold typically valued at about the same as sixty ounces of silver.
Recent developments with the introduction of gold exchange trading funds (ETFs) provide another convenient means for investors and traders to speculate on hedging gold against the gold price. These offer many of the same basic advantages that the Central Fund of Canada offers in terms of convenience and easy availability. The significant difference between the Central Fund model and ETFs is that, as open-ended vehicles, ETFs will tend to trade close to their underlying NAV.
Central Fund of Canada, like other closed-end vehicles, will trade at a discount or premium to its NAV which can sometimes be quite significant. (Currently trading at a premium.) What the authors particularly like about CEF is its track record: 46 years of existence. We believe that narrow sector ETFs still have too short a history for all of their advantages and disadvantages as trading and investment vehicles to have fully emerged and we still do not have the same level of comfort with ETFs that CEF provides us. At the very least, as something of an older and more mature cousin to today’s hot gold sector ETFs, we would suggest that investors/traders in the latter may have an interest in taking a closer look at Canada’s not-so-well-known Central Fund.
Full Disclosure: The authors trade in and out of stocks on the very short term using their own “Contrarian Ripple Trading” technique. Of the stocks mentioned here, CEF, ABX, and NEM have recently traded.