How to Invest in Gold

China’s Gold Investment

Steve Sjuggerud — Thu, 11 Mar 2010 10:48:40 +0000

How can China build its gold reserves if it doesn't Buy Gold...?

"A FEW FACTORS limit our ability to increase [our] Gold Investment," said China's chief foreign exchange manager, Yi Gang, in a speech this week, notes Steve Sjuggerud in his Daily Wealth email.

Western investors have long speculated China will start Buying Gold and selling its hoard of US Dollars at some point. (China's hoard could be literally trillions of US Dollars.) It would be the first step in a "Doomsday" scenario for the greenback.

Just imagine – China trades in its Dollar reserves for Gold Bullion. The value of the Dollar crashes...and US interest rates soar, as China is no longer willing to buy US government Treasury bonds.

Some investors have said China has a perfect way to do it, available right now. The International Monetary Fund (the IMF) has a near-200-tonne hoard of gold that it wants to unload.

But if China actually used all its Dollar reserves to Buy Physical Gold, it would completely overwhelm the market. It would end up trying to buy about a third of all the gold ever mined in the history of the world. There's no way it could get all that gold without sending the price to outrageous levels.

It seems Mr. Yi recognizes that. He essentially said gold is too volatile, the historic returns aren't that great, and any gold buying by China would "certainly" increase Gold Prices.

If Mr. Yi is to be taken at his word, in short, China doesn't have plans to Buy Gold in the open market. And Mr. Yi's comments are in line with recent comments from the China Gold Association, who told the China Daily newspaper that it is "not feasible for China to buy the IMF bullion, as any purchase or even intent to do so would trigger market speculation and volatility."

So how would China acquire gold if it doesn't buy it? This is where it gets interesting...

An official from the China Gold Association told the China Daily that rather than acquiring Gold from the IMF, China would Buy Gold directly by buying gold mines "abroad". Rather than buying physical gold in the open market (where China would be the 800-pound gorilla in the room), China plans to buy future production instead.

If that's true (and there is some sense to it), then how should you play it? Dennis Gartman reported on this yesterday, in his Gartman Letter:

Perhaps we are to begin owning gold mines rather than Gold Futures or Gold ETFs. We have avoided owning mines for years, preferring the "purer" play of owning gold rather than the mines, for we fear being exposed to poor mine management, or accidents in a mine that might do damage to the equity while gold itself moves higher. But if the Chinese authorities want to own mines, perhaps we have to consider doing so also...

I've done more than consider buying Gold Mining companies. In the latest issue of True Wealth, my subscription newsletter, I recommended Buying Gold mines as the best way to have exposure to gold right now.

The reason is simple. This chart sums it up...

Gold is up 70% since the summer of 2006. Meanwhile, gold stocks (as measured by the Gold BUGS Index) have done nothing.

Usually, a 10% move in gold would mean a 20% move in gold stocks. But this relationship broke down in the financial crisis. Now, either the price of gold needs to crash... or the price of gold stocks needs to soar to correct this anomaly.

The timing might be just right. Gold mining stocks are down, and it's just coming to light that the Chinese authorities could prefer acquiring gold mines – which give the country a permanent supply – over Buying Gold in the open market.

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Gold Cycle Broken?

The Gold Report — Thu, 11 Mar 2010 10:33:32 +0000

Yes, kind of, says one analyst. The seasonality of gold has broken down...

DON'T COUNT out the US Dollar just yet, not as the Euro waivers.

So says Louis Paquette, who launched Emerging Growth Stocks in 1995 to provide investors and speculators with a unique alternative to what he saw was a growing problem with corporate governance and conflict of interest on Wall Street.

Here he speaks to The Gold Report about the outlook for the US currency, plus the fact that the "seasonality" of Gold Prices and gold-mining stocks has broken down...

The Gold Report: In your February newsletter, you noted the negative sentiment towards the Euro driven by fears of the PIIGS's defaults. But you pointed out that states such as California are fairing far worse potentially than Greece, Italy, Spain or Portugal. So why is this boosting the Dollar and depressing Gold Prices?

Louis Paquette: For a while now, the Euro has been the currency that's weak. The attention has gone to Greece and people are thinking, well what's going to happen if this contagion spreads to Spain and other countries that are looking bad over there? We've just seen this shift after a whole year of the US Dollar falling. It got really overdone. It got to be a really crowded trade and now sentiment has shifted negative against the Euro, which has allowed the US Dollar to recover.

Interesting note on a technical basis, the US Dollar Index has now had a 50% retracement of the negative down move that took place in 2009. So who knows? Maybe we've seen enough of a rebound now of the US Dollar, and the Euro has come down enough that we're going to see a reversal now. Maybe the US Dollar will have a downturn now but, at the moment, all the attention – the negative attention – is towards the Euro.

TGR: Well factoring into the US Dollar I'm sure, California's population is well over three times the population of Greece. It's the largest US state and it's in serious trouble financially, many say much more than Greece. Are the eyes of the world investment/finance community just in the wrong place right now?

Louis Paquette: I don't know if it's the wrong place because the Euro has a really serious problem. The ratios – the debt per gross national product and the debt ratios – in many countries in Europe and England are terrible. I don't know if the investment community is looking at the wrong place. These things ebb and flow. For a while, the negative sentiment and the selling has been on the Euro; and that'll continue until it gets to be too much, and then something will happen. Some news event will take place regarding the US Dollar, and then it will have a decline. That's just the nature of markets. They move back and forth.

TGR: When the US Dollar declines, are we expecting to see a focus back onto the Euro, or would we start seeing focus on other currencies such as the Yuan or Rupee?

Louis Paquette: I think the focus will go back on the US Dollar because it will have had a pretty darn good move up and the short sellers will probably swoop down on the Dollar again. In terms of other currencies, we just keep hearing good things about the Canadian, Australian and Indian currencies. So I think the bears will circle the US Dollar again sometime later this year.

TGR: How do you think the Chinese Yuan factors into the equation right now?

Louis Paquette: Well you can't pressure the Chinese to do anything. Telling them to let their Yuan rise is almost counterproductive. They may not let it happen just because you want it to. They're going to do whatever they want no matter what.

TGR: As we move into this bear focus on the US Dollar, and we know there are issues with the Euro, are we going to see a decoupling from the Euro-goes-up-Dollar-goes-down (or vice-versa) mindset, to Euro-and-Dollar-go-down, and Canadian, Australian Dollars go up?

Louis Paquette: That's what I think is going to happen.

TGR: How does an investor play that?

Louis Paquette: It's kind of a race to the bottom with most of these currencies, even with Canada's. I hear the big, big investors saying, Canada's such a great place, and we're supposed to have a conservative government, yet they're going to have a huge massive deficit this year. Even the most favorable countries are now spending beyond their means and I guess the only way to play this is to have some gold in your portfolio. Have some raw gold, have some bullion and have some shares of good mining companies. If you're really aggressive, talented and you know how to short and play the futures markets, then you can try and time these, the bigger declines. Sooner or later the US Dollar will top out again. If you're really comfortable with doing that you could do a short sell on the Dollar with the futures markets but I'm not that comfortable doing that kind of thing. So I just hold gold.

TGR: Do you feel confident that the Canadian banking system is going to remain strong given what you've just said, or do you just see that waning a bit too?

Louis Paquette: Well the corporations themselves have run themselves fairly well. But sadly with – it seems like anytime the population figures out it can vote someone in who spends more, that's when you run into trouble. It seems like every country is doing that. Perhaps China and India aren't, but here in the West that's happening. I'm not comfortable with the government, but the Canadian banking sector is still being run fairly prudently.

TGR: There's a growing belief of a double dip recession for the second half of 2010. You refer to Dan Arnold's work, The Great Bust Ahead, predicting the bust will begin in 2013. If there is a bust ahead, how should the typical investor play a busting market? Some feel the prudent strategy is to go long in cash/gold avoiding equities whose value will fall during a bust. Is this your opinion?

Louis Paquette: I would stick with holding some gold equities of really good companies. If we do get a real meltdown in the currencies, it's going to impact the price of gold – and the companies should make terrific profits. But will they melt down, too, in a big meltdown? I really don't know, but I would just hold some. The one thing I would be confident in doing is saving a lot of cash. I would short stuff and own more cash. I would not buy luxury items and I would save cash.

TGR: In our last interview with you, we discussed the Typical Seasonality in Gold, especially gold stocks, both of which have a fall and a spring rally, followed by a typically quiet summer. At that time, you were uncertain if the climate had truly shifted for gold, and were unsure whether or not that seasonality was breaking down. A year later, do you think it has? Also, has the psyche for accumulation of the metal itself moved into the acquisition of promising junior or mid-tier Gold Mining company stocks?

Louis Paquette: Let me answer the second question first. For the last year, the emphasis has moved toward the metal. The Gold Mining shares? I'm looking at a chart right now of appreciation of gold and gold shares, and the gold shares have gone sideways for the past two years and gold has gone up. So for the moment, there's better value in the gold producers, in the shares of the companies, and people have been buying the bullion price.

The first question, has Gold Seasonality broken down? I think the answer is yes, kind of. The last buy time for seasonality was last August. That did work. The price of gold started to take off after that. But now when it comes to the high point, gold peaked on December 3rd; it hit a parabolic high at that point – and looks like a cyclical high now – and it's not strong. It's supposed to be peaking around now, and we're $100 or so below the peak. I would say the seasonality is breaking down because the price is now being driven by Gold Investment demand as opposed to physical demand for jewelry. So the answer is yes. The seasonality is breaking down and you have to revert to other methods to pick your highs and lows now.

TGR: To what extent do you believe news and the news media can make a market? And has the gold market yet to be made?

Louis Paquette: I think it has a lot to do with it. And I don't think we've seen the full extent of it yet. We haven't seen a media-driven parabolic rise yet. You don't see the average person lining up to Buy Gold coins at this point. I think that day is going to come, but I don't believe we've seen it yet.

TGR: What are you recommending for portfolio diversification with regard to gold stocks, Gold ETFs, and the physical metal?

Louis Paquette: The leveraged two-times ETFs were really popular here in Canada, and I'm completely avoiding them. They experienced time decay. So zero for the leveraged ETFs. And the main focus is on junior mining companies, exploration situations and near producers with growing reserves. I'm not Buying Gold anymore. I used to buy it years ago in the beginning first few years of the bull market, but I just sit on that. That's 5%, 10% of one's portfolio in the metal, in the Gold Bullion, and for me a lot larger than that with the gold share (but I specialize in that). So I don't know what the good number is for the average investor, but I'd say maybe 5-10% of the gold shares of selected junior mining companies.

TGR: Earlier on we were talking about a double dip recession. You said people should short stop and go long on cash. So the suggestion is to hold cash; but really early on we were talking about the devaluation of the Dollar and the Euro. How is this a good strategy?

Louis Paquette: Well, all I can tell you is what I'm also doing – taking a fair number of those Dollars and owning stocks that pay good dividends. At least I'm making an income with that money. I guess that's where you have a portion in the gold sector too, if the currencies are going to devaluate. Consumer goods are going to fall in value even faster than everything else.

TGR: Value declines as soon as you take it out of the store.

Louis Paquette: Exactly. So I'm not in a big hurry to buy brand new cars. They're going to be cheaper in the future.

TGR: So you were talking also a bit about having 5-10% of your portfolio in metals, which leaves another 90% of your portfolio in other types of things. Given that there are significant reports of green shoots and some positive economic news, at least coming out of the US, what other sectors would recommend our subscribers invest in so they have a balanced portfolio?

Louis Paquette: The areas I like are gold and energy. On weakness, I have been purchasing shares of these income trusts that pay 5-10% yields. So I'm about 50% cash and about 5-10% in the metal, say 20% in Gold Mining shares and the balance in energy shares. Also in special little situations, I've got the odd investments – biotech and even a social media company. Some very small micro cap situations are also in there, not specific to any sector, but "bottom up" selections based on the merits of the company.

TGR: In terms of energy, are there specific subsectors of energy that you're focusing in on?

Louis Paquette: Yes. I've got a love/hate relationship with natural gas right now. The production community seems to be determined to drive the price to zero. But sooner or later, this natural gas situation is going to turn around. They're going to deplete all these new reserves they've found and there's going to be a shortage of it. I'm not saying in the next month or so, but in the coming years there may be a great opportunity in natural gas.

TGR: Lou, thank you so much for joining us.

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