How Much Further Could Gold Prices Fall?

Two potential debt crisis outcomes – with big implications for Gold Prices...

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Gold: A Case of Mistaken Identity

Is gold a safe haven? A risk asset? Actually, it's neither...

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Food Riots & Gold

The risks to China, India and global Gold Prices if broader commodity prices rise further...

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Silver vs. Gold: Industry vs. Investment

A bullish view on Silver Prices via a bearish view on gold...

VICE-PRESIDENT of marketing in North America for Heraeus Precious Metals, the German-based refinery group, Miguel Perez-Santalla doesn't buy the idea of Gold Investment taking prices much higher from here.

Silver Investment, however, isn't as crucial as industrial use – now growing strongly, he says.

Here Miguel Perez-Santalla talks to Mike Norman at Hard Assets Investor about what he's starting to see silver now that prices have shot to 30-year highs...

Hard Assets Investor: Putting gold to one side for a moment, what's your overall outlook on the other precious metals?

Miguel Perez-Santalla: Well, first off, all the precious metals are following along with Gold Prices, and the weakness of the Dollar, which is another thing holding up the precious metals markets. But there are some very strong fundamentals behind silver.

Silver consumption has gone up greatly. And there's some tightness in the physical market, though the mines are delivering more. And it takes time for it to hit the marketplace. And that's because a lot of the electronics industry and the jewelry market are growing tremendously, and because of the price of gold being so high.

HAI: As a substitute...?

Miguel Perez-Santalla: Yes, as a substitute. So there's a lot of demand for silver. It has a very strong fundamental [outlook]. And I think that even if gold drops percentagewise, silver should hold on to more of its gains.

HAI: Now silver's trading around $23 an ounce, but was $50 at one time back in 1980.

Miguel Perez-Santalla: But that was market manipulation. The Hunts' cornering of the silver – or attempted cornering. It didn't work out so well once the CFTC got involved.

HAI: Wouldn't you think there would now be pressure or desire to see more controls put on the market? The commercials in the market, who have to deal in this, and the jewelry industry, for them it's hurting...

Miguel Perez-Santalla: Well, what's interesting about that is being someone who believes in the free market. At the same time, there have to be rules and boundaries set in place to protect industry, and to protect the individuals. And for instance, when investment money is going in large quantities into these metals, who's paying for it in the end is the consumer.

For instance, palladium too is also reaching all-time highs. Well, it hasn't reached all-time highs; it reached $1000 in 2000. But it's very high right now. And why? Because of the investment money. Otherwise, it wouldn't be as high because the primary consumption of palladium is the automobile.

HAI: So that speculative element pushes up the price, and that's passed along to consumers.

Miguel Perez-Santalla: There have to be rules. Just like a football game. You and I – I'm a short little guy and you're a tall, big guy. If we were playing football together, you'd cream me. It wouldn't be fair.

HAI: You'd probably run right past me.

Miguel Perez-Santalla: But that's what happens in the marketplace. Now we have big bullies playing in the market, which are the banks and the funds with their investment capacity. They could just outrun the small guys, and the small guys get crushed if they don't join the herd.

HAI: Well, that's the thing. And they have been joining the herd in quantities that continue to grow. So you're feeling is that they're going to end up being disappointed.

Miguel Perez-Santalla: Well, at a certain point it's going to turn. It's going to turn. Just like the tulip scare in Holland back in the 16th century or whatever it was.

HAI: Right, which devastated the whole Dutch economy.

Miguel Perez-Santalla: Right. When a house sold for one tulip bulb, that was insanity. And that's the kind of thing we're seeing now. Because really, what do you do with gold? If the jewelers can't sell it, and it's getting too expensive to use...

HAI: You're saying there's no intrinsic value to it?

Miguel Perez-Santalla: Well, there is...It's beautiful. Gold is beautiful. But before King Croesus decided one day that gold was worth 15 head of sheep, no one picked up on gold. But that day when gold became a currency is when it got its value. Unless the government empowered decrees that it has to be money, and exchangeable in the public hemisphere, it's not money.

HAI: What do you think about the fact that the production of gold – and we just kind of agreed that at least right now it has no intrinsic value – the production of gold uses up real resources...

Miguel Perez-Santalla: Well, there's a flip side to that. Obviously, it's producing and consuming all those things, and creating jobs at the same time. There are jobs created around any industry. So I'm not going to knock the entire Gold Mining industry. And there is a demand for gold and jewelry and whatnot. But now the demand has created a bubble, and it's not being used for its primary, core fundamentals. So that, in a way, is true. Yes, it's driving away resources from other areas where we should be exploring and investing our monies.

HAI: Very interesting. Thank you, Miguel.

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“Smart Money” Shorts Gold

But does that mark the end of gold's bull market? Hardly...

YOU NEED both buyers and sellers to make a market, says Brad Zigler at Hard Assets Investor, especially in markets like the one in which gold is traded.

There's no shortage of players in the gold market presently. And there are, in fact, sellers aplenty. Commercial traders, as they're known, have been building up a net short position that could soon outsize the one which set up gold's December sell-off.

At last count, commercial traders held the equivalent of 326,571 futures contracts short,  betting that prices would fall. As of October 20, 2009 – six weeks ahead of an eventual $183 swoon – commercial traders were short of 328,344 Gold Futures.

Who are these commercial traders? Well, you can, as the Commodity Futures Trading Commission does, break up commercials into two groups.

• The producers/merchants/processors/users contingent includes entities that produce, process or deal in gold and use futures to manage or hedge the risks associated with those activities;
• The other lot, swap dealers, use the futures market to hedge the risk of dealing in contracts for gold known as swaps. A swap is a contract calling for the exchange of cash flows. The buyer of a gold swap might agree to pay the dealer a money market return (typically a spread above interbank lending rates) in exchange for the return generated by gold from a designated starting point.

Swap dealers are primarily investment banks that use futures to manage residual exposures left over after matching long and short commitments internally on their books.

Over the past four years, producers/merchants/processors/users have accounted for 69% of commercials' net short positions. Swap dealers weigh in at 31%. And the current surge in commercial short positions is an indication that the so-called smart money – those that actually deal in Gold Bullion – are growing increasingly concerned about possible weakness in gold's price.

Selling Gold Futures at today's value, after all, provides them a hedge against the receipt of lower prices in the cash market later. But does this mean we're due for a gold sell-off? Given current market circumstances, probably. Is this the end of gold's bull market? Hardly. There'd have to be a substantial decline – down to the $830 level presently – to put gold's long-term trend in jeopardy.

Given the six-week lag between the last high net short position and the market's top, we might not see a price break immediately. But its likelihood has increased substantially. You can use this as an opportunity to lighten up or to add to your gold positions as you see fit.

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Gold Futures: Retail Investors Drawn to Mini Contracts

Gold Investing with the leveraged risk of "mini" futures explained...

MUCH OF THE MEDIA BUZZ around Gold Investing these days centers on ETFs and physical bullion, writes Lara Crigger at Hard Assets Investor.

But don't overlook another way to get your precious metals fix: Gold Futures contracts.

Both the NYMEX and NYSE Liffe US – the US futures exchange of NYSE Euronext – offer futures contracts. They come in standard, 100-ounce lots, and also in "mini" 33-ounce sizes.

Gold Futures contracts aren't as arcane or complicated as they seem, but you should keep a few things in mind before investing, says Jennifer Ropiak, vice president at NYSE Liffe US, NYSE Euronext's US futures exchange.

Since 2008, Ropiak has managed business and product development for the exchange's gold and silver futures and mini futures contracts. Prior to joining NYSE Liffe, Ropiak worked at a CTA and at a small hedge fund specializing in gold. She has over 20 years' experience trading and marketing precious metals, including stints at Morgan Stanley, AIG and Dresdner Bank.

Recently, we sat down with Ropiak to get her perspective on the mini futures market, including why silver mini futures have seen a bump in open interest, what new investors should consider before buying a mini futures contract, and whether proposed government regulations would send derivatives business overseas.

Hard Assets Investor: Given gold's trajectory over the past several months, how has volume or open interest changed in the gold mini futures market? Or, for that matter, the silver mini futures market?

Jennifer Ropiak: We're seeing a lot of active trader and retail trader flow. I think that is because the sharp rise in price has made the full-sized contracts less appealing to some traders. But people still want to have some exposure to precious metals prices, so they're using our mini gold contract [which is 33.2 ounces], as opposed to the 100-ounce gold contract. Our mini gold contract volume is up 71 percent from this time last year, and our open interest is up 75 percent. Average daily volume in June is about 10,000 contracts.

We have also seen much more interest in mini silver: Our mini silver contract is 1000 ounces, versus a standard contract, which is 5,000 ounces. Mini silver has averaged a daily volume in 2010 of 3,200 contracts, which is up 25 percent from 2009.

HAI: Are the increased inflows a direct result of gold's price rise? Or are investors judging silver's fundamentals separately from those of gold, and moving into the metal accordingly?

Jennifer Ropiak: Many people view silver as "poor man's gold," and as a cheaper item, I think silver is benefiting from the interest in the precious metals complex in general.

But on the other hand, silver is an industrial metal, too. So at certain times, depending on economic sentiment and the fundamentals, silver prices can move on the back of either Gold Prices or copper prices.

HAI: So six of column A, half a dozen of column B.

Jennifer Ropiak: Exactly. If you feel the economy will recover strongly, you might want to be long in silver, because it's an industrial metal. Also, silver prices are more volatile than Gold Prices, so if you think precious metals prices are going up, you might choose to buy silver, because you would expect it to have greater percentage gains than Gold Prices. But you might choose the reverse, and Buy Gold if you believe the economy's still going to have difficult times ahead.

HAI: Certainly what happens next is still up in the air, given the Eurozone crisis overseas. How do you think inflows into both silver and Gold Futures will reflect this uncertainty over the next couple of months?

Jennifer Ropiak: What we have read from many analysts is that people who had GLD [the SPDR Gold ETF Trust] in their portfolio since its launch five years ago definitely saw a diversification benefit. People looked into their portfolios and realized, "This works."

So as more and more Americans learn about Gold Investing, as well as silver's portfolio diversification benefit, and the market looks for different ways to participate, I think that our mini gold and mini silver futures contracts will only benefit. A lot of analysts say that you should have 5 or 10 percent in precious metals in your portfolio, and of course, mini gold and mini silver futures are a great way to achieve that.

HAI: But many investors are warned away from trading mini futures, either because they're too difficult for novices, or because of liquidity or risk concerns. Should only sophisticated investors be dealing in these contracts?

Jennifer Ropiak: Certainly brokers should have strict standards they'll follow before they let a client open a futures account. And when someone starts to trade, they usually first start in equities, and then learn about options and futures.

It is important that the investor has a solid understanding of the power of leverage. For example, to take a position in mini Gold Futures, you only have to put up about 6 percent of the current value of the contract. The current value of the contract is about $40,000. The initial margin is $2,248. Then every day after that, you reap the full benefit or full consequence of the movement in prices. So if the price moves $2, depending on your position, you will have a positive or negative mark-to-market of 33.2 ounces, multiplied by $2, or $66.40. That leverage is something that a lot of active traders appreciate. With a mini futures contract you can get that exposure to gold, and the balance of the value of the contract – that 94 percent – you can put into an interest-bearing vehicle or another investment. Leverage is powerful, but you definitely do have to understand how it works.

Another advantage of these futures is that it's possible to actually take physical delivery. If you're long three mini gold contracts, you can stand for delivery and receive three Warehouse Depository Receipts. You can then swap these WDRs for a vault receipt, which allows you to remove the 100-ounce Gold Bar from the exchange-approved vault. The same is true for mini silver, but you need to have 5 WDRs to remove silver from an exchange-approved vault.

If you are long less than 3 mini gold (or 5 mini silver) futures and stand for delivery, you will receive WDRs that are backed by the real metal stored in exchange-approved vaults, but you won't be able to remove the metal. There are other futures exchanges with precious metals mini futures, but their volume is negligible in comparison to ours. I think the reason that we [NYSE Liffe US] have the most volume and open interest is that our contracts are actually backed by physical metal.

HAI: Certainly there's been increased desire from precious metals investors to be able to take that physical delivery.

Jennifer Ropiak: I think Americans are genuinely concerned about their future, and gold is considered by many as a store of value. But prior to the launch of GLD, if you were interested in owning precious metals in the US, outside of being a coin collector, it was almost un-American. But in Asia, India and Europe, it is common to be invested in gold and silver, and it has been the case for a long time. Silver for Indian dowries is a classic example, but globally, individual investors have been very comfortable with precious metals for a very long time. We as Americans are simply catching up.

HAI: We're behind the curve...

Jennifer Ropiak: Indeed. If you look at some of the numbers of the physical trade of gold over the past couple of years you'd see that, ironically, while there's been a rise in Western investments, the Chinese, Japanese and Indians have been selling some of their holdings into this rally. The East has been selling into this rally to the West.

HAI: Of course, the World Gold Council said that China and India will remain the real heavyweights of gold demand for the foreseeable future. Rising demand in the States won't really make a dent, not compared to the level the Chinese and Indians are buying at.

Jennifer Ropiak: Well, there's lots of levels that could contribute to the buy side. There's the individual level, the institutional level and the level of the central banks. For a long time, the central banks were only concerned about the amount of dollars they had in their reserves. Now they're concerned about the amount of Euros they have in their reserves. So what can they do to diversify? One option over time is to Buy Gold.

HAI: So do you have any plans at the NYSE Liffe to launch any other precious metals futures contracts? For example, we've seen a major rise in investor interest in the platinum group metals, especially since the launch of the platinum and palladium ETFs.

Jennifer Ropiak: We are absolutely looking at that market. But the regulatory authorities – in this case, the CFTC – would want to be assured that the deliverable supply is plentiful enough. When you start contracts, the first thing that's always asked is about the deliverable supply. So before anything happens, the CFTC would have to feel absolutely comfortable that there would not be a squeeze in the market.

HAI: In a recent interview, Jim Rogers said when it comes to the new proposed regulations for the derivatives market, the US is "shooting itself in the foot," and that we're essentially just "giving business away" to the rest of the world. Do you agree? If the government imposes new regulations, will the market just shift overseas?

Jennifer Ropiak: That's the great dilemma, of course. In the precious metals ETF universe, GLD has all the volume. Why? People all over the world, whether they're in Europe or Asia, use the United States' ETF, because they like the regulatory framework that's in place for securities.

But if there are going to be a lot of changes to the rules governing the futures and over-the-counter markets, there could be a risk of volume fleeing to more opaque markets. In other parts of the world, banks feel strongly about protecting their clients' privacy, and they may not welcome the ability for an American regulatory body to inspect their books. Our role at NYSE Liffe US is to offer a transparent market. We look forward to our continued growth, as more volume looks to go on exchange.

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Gold – Not Silver – “Becoming Currency”

Does the Gold/Silver Ratio really mean a strong revival for "poor man's gold"...?

"GOLD IS CURRENCY," says Andre Julian, co-manager and co-owner of brokerage firm OpVest.

Registered in the US commodity and Gold Futures market since 1996, he's worked as one of the top brokers at the United States' leading brokerages. Here he speaks to Hard Assets Investor about why he favors gold over Silver Bullion today...

HAI: Starting with gold, which recently ran up to a new all-time price high. Are we facing a hyperinflation? What would gold do in a deflationary environment?

Andre Julian: I think we are in a deflationary period for the short term. Obviously, they're printing a lot of money around the world. And globally, if you look at the global economic factors, you'll see that eventually there should be inflation, just based on the amount of money that will be out in circulation.

But I don't really buy hyperinflation right now. I think that it's way too soon to even think that something like that could happen at the moment. But with gold, it's not only a hedge for inflation, it's also becoming its own separate asset; it's becoming a currency. And right now, currencies globally are ruling the investment world.

You have to look at the Euro. Everything has fallen because of the Euro right now. The Euro has collapsed, the stock market is having a huge retracement. And other currencies, like the Japanese Yen, they're going up, the carry trade is unwinding. So everything has to do with currencies this week, last week, probably the past month or so. And gold is now also being thought of as a currency and a safe haven.

HAI: How is it a currency? It's not used as a means of exchange...

Andre Julian: I think it's a currency in that it's an asset, and you can exchange that asset at a later date for a currency of your choice. If you're in Europe right now, a lot of people were trading their Euros for gold. If you have a weaker currency, and you think that your currency is getting weak, why not trade it in for a currency that's going to stay strong? So again, I know we hear it, and I know that it's a "currency". However, it's a tradable asset. And people like holding hard assets.

HAI: Yet you have Treasurys on the one hand, which represent a deflationary and a flight to quality; and you have gold on the other hand, which represents the loss of faith in paper money. Both are going up. Can that be correct, or is one of those markets wrong in its message?

Andre Julian: I think they could both be right at the same time. You have short term, you have long term, obviously. I think right now both gold and Treasurys are right because you have different segments of the population, you have different investors running them for different reasons. The Fed has been forcing our hand for years. They've kept interest rates really low, so they're trying to get people to speculate. And a lot of people are just so concerned with safety right now that they're running into the Treasurys. They're willing to accept a really low yield.

Then you have other people that, obviously, are going into gold because they want that hard asset, they want that tangible asset. Because you see inflation, deflation, it doesn't matter – over the past 10 years, look at the track record of gold. It's up every single year. It's been up nine years in a row. It's up 24% last year, 8% year-to-date. And it's slow and steady.

HAI: Let's talk about silver, which some people call "the poor man's gold". It got up to $50 back in 1980, when the Hunt Brothers tried to corner the silver market. Will we ever see that price again?

Andre Julian: You know, I don't like to say "never", but I don't see why we would ever see that price. A lot of it did have to do with the Hunt Brothers; a lot had to do with the speculation. They were holding on. They were trying to corner the market. You had a lot of exchanges that were short. And as it kept on running out, there was panic.
 
But that was just the Hunt Brothers coming out saying, "We're going to corner the market on silver." I don't see that happening again. There is an argument that silver is well below where it should be when it's compared to gold. But I don't buy that argument at all.

HAI: You're alluding to the Gold/Silver Ratio?

Andre Julian: Yes, the gold/silver ratio. And that's fine. I think gold is really, again, its own animal right now. Silver typically is used in industry as well, so you can put it in that batch of metals. I don't see anything big for silver to the upside or the downside. I think it's going to keep on kind of trickling along.

HAI: How would you advise an ordinary investor to get involved in gold? Through an ETF? Should they buy a Gold Futures contract? Options? Gold Bars? Gold Mining stocks...?

Andre Julian: You know, I think it really depends on who you are. We always want to give advice to a person based on their pocketbook, based on how much money they have at risk, where they want to be. Look, if you have deeper pockets, get in the futures. Get in the futures and just buy. Buy in the dips. Continue buying on the dips. When the contract rolls over, buy some more. Just hold it, if you have those kind of pockets.

If your pockets aren't so deep, and maybe you just want to stick a part of your portfolio into gold, look to an ETF, or look to options, like the call options. You know, when the market comes down, even some...a spread, a bull call spread, which is a little bit less expensive and it gets you closer to the market.

So again, it depends on your pocketbook. But it makes sense right now as a hedge against what's going on in the stock market; more than a hedge against inflation.

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Zig-Zagging in Gold & Stocks

So, how's that S&P-gold ETF product working out for investors...?

AS MANY INVESTORS have learned recently, financial innovation comes with a price, writes Brad Zigler at Hard Assets Investor.

The cost of credit default swaps, for example, is opacity. Very few investors knew how the bloody things worked or how they'd behave under market stress, until they blew up.

Not all new financial products are time bombs, though. Some are simple enough to understand, but still require scrutiny by investors to appreciate all of their nuances. Take the recently introduced UBS E-TRACS S&P 500 Gold Hedged Index ETN (NYSE Arca: SPGH) for instance.

These notes – unsecured, zero-coupon obligations of the Union Bank of Switzerland's Jersey branch (that's the Isle of Jersey, not the Garden State) – are designed to deliver the combined returns of the S&P 500 Composite and long positions in nearby Comex Gold Futures. The notes accomplish this by tracking an index that equally weights, by way of monthly rebalancings, the equity and gold exposures.

The correlation between gold and blue chip stocks is historically low or, as now, negative. Presently, the rolling 30-day correlation between Comex gold and the S&P 500 is minus 24%. Thus, for now, gold provides the "zig" to an investor's portfolio, while the stock index delivers the "zag".

That's not always so, however. As you can see from the graphic below, gold and stocks are sometimes fellow travelers. In the early part of this year, for example, the correlation peaked and lingered at 80 percent – positive 80 percent.

So there's your first caveat: Gold's diversification benefit is an ethereal thing. Sometimes it's powerful; at other times it's nonexistent and may, in fact, be a detriment, riskwise.

SPHG has just logged its 90th day of trading, so now's a good time to take a look at the notes' behavior to see if they're actually delivering a benefit that justifies their cost. At 85 basis points (0.85 percent), SPHG's investor fee – as exchange-traded notes go nowadays – is not the most expensive item on the market.

You have to wonder, though, if you couldn't do the same thing on your own by combining exchange-traded securities tracking the S&P 500 and gold.

After all, you can get the blue chip exposure for only 9 basis points through the Standard & Poor's Depository Receipts (NYSE Arca: SPY) or the iShares S&P 500 Index ETF (NYSE Arca: IVV). And Gold Bullion exposure can be had – without fear of contango, if without any gold ownership either – for just 40 basis points with an investment in the SPDR Gold Shares Trust (NYSE Arca: GLD). [Ed.Note: You can cut that to 12 basis points per year by owning physical Gold Bullion at BullionVault...]

So an equally weighted combination of the equity ETF and the gold grantor trust would effectively cost just 25 basis points. But would you get the same results with the "do-it-yourself" version?

Well, yes and no. Using SPGH's index methodology, which calls for rebalancing on the fifth business day of each month, the indicative values of the UBS note and the DIY package would have been virtually identical over the past 90 trading days.

Unfortunately, exchange-traded notes don't always trade at indicative value. The more illiquid the note, the greater the disparity between its quoted market price and its indicative value.
The market for the SPGH note is especially sparse. Since SPGH's inception in February, only 712 notes change hands on an average day.

The IVV fund's net asset value has meantime declined by 0.19% since February, while the GLD grantor trust's value appreciated by 10.42%. Here, rebalancing served its purpose well, by producing an incremental positive return.

The wide spread between the apparent returns and the gains measured by the indicative values is largely a timing artifact. The iShares ETF and the GLD trust are two of the most actively traded exchange-traded products extant. There's typically very little time lapse between trades in either product. There are long gaps between SPGH trades, however. Sometimes the note won't trade for days on end. Even though the notes' indicative value is refreshed every 15 seconds, the last sale data disseminated by news vendors make the note look woefully out of sync with the market.

Spreads are wide in the SPGH market as well. At last look, there was a 1.4 percent gap quoted between the notes' bid and offer. IVV and GLD, on the other hand, are very tight markets, making realization of the indicative value return more likely.

The tighter spreads obtainable with the DIY portfolio have to be balanced against higher potential tax liabilities and commissions. At each monthly rebalancing, two commissions will likely be charged: one to sell shares of the previous month's outperformer, and another to purchase shares of the underachiever. Obviously, the SPGH note bears no such frictional costs, as there's no actual portfolio maintained.

The gains realized by rebalancing the DIY portfolio in a taxable account may increase an investor's tax liability, unless offsetting losses can be utilized. What's more, at least some of these gains are likely to be characterized as short term – and therefore taxed at ordinary income rates.

Perhaps the most important of SPHG's costs is that which can be discerned only by careful inspection of the note's prospectus: the call provision. Yes, these notes are callable at UBS' discretion. Similar to the iPath notes described in "Callable iPath Notes Chart A New Course," call protection lapses a year after issuance (in other words, Jan. 31, 2011). No premium will be offered by UBS; the notes are redeemable at their then-indicative value.

The call feature may also affect the notes' prices, especially when the call protection lapses. Arbitrage between the SPHG notes and their noncallable proxies – such as the DIY package we've examined – may force the notes to trade at an even larger discount.

So which is better, SPGH or the DIY package? It depends, of course. The DIY package has added tax consequences, but SPGH's call feature alone may make these notes unpalatable to long-term investors. In either case, be sure to do your homework, and run the numbers before investing.

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Gold Miners Or Gold?

Analyzing the link between Gold Mining stocks and Gold Prices...

WITH GOLD currently hovering near all-time record highs, it stands to reason that Gold Mining stocks would be closely tied to that of the yellow metal, writes Charles Armstrong at Hard Assets Investor.

But just how close is the connection?

Below, I've shown the price of four of the world's largest gold miner stocks by market capitalization, and compared it over the five-and-half-years to June 1, 2010 with the continuous front-month Comex Gold Futures price.

The big Gold Mining stocks are Barrick Gold (NYSE: ABX); Goldcorp (NYSE: GG); Newmont Mining Corporation (NYSE: NEM); and AngloGold Ashanti (NYSE: AU)...

Keep in mind that I had to use two different scales here, with gold itself (the big pink line) chasing prices above $1200 per ounce, and the big four miners bouncing between $10 and $60 per share (right and left axes, respectively).

But notice how truly divergent the Gold Mining stock prices are. If gold miner stock prices depended only on the price of gold, what should account for the variance...? Rather than look at each line over a time series, let's compare each company to the Gold Bullion price directly.

Quick refresher for statistical students: R-squared is the degree that the change in one factor in a system (in this case, the mining stock price) can be attributed to or explained by the change in the other factor in the system – that is, in this case, the Gold Price. Beta, on the other hand, is the amount by which these two factors are connected, whereby a beta of 1.0 would imply that if the company's stock price increases by $1, so too would the Gold Price.

First, the world's largest specialist Gold Mining stock, Barrick (ABX):
R_squared: 0.598
Beta: 24.146

Next up, GoldCorp (GG):
R_squared: 0.791
Beta: 22.592

Then Newmont (NEM):
R_squared: 0.043
Beta: 7.366

And fourth, AngloGold Ashanti (AU on the New York Stock Exchange):
R_squared: 0.026
Beta: -4.438

As you can see, Barrick and Goldcorp behave much like you'd expect, and are relatively correlated to the price of Comex Gold Futures.

But strangely enough, Newmont and AngloGold Ashanti appear to be entirely disconnected from it. Indeed, AU's negative beta means that when gold goes up, the price of AU actually goes down, and vice versa. (Although admittedly, with an R_squared under 0.03, I'd be hard-pressed to say there's any correlation at all.)

Many factors may account for this discrepancy: the effect of currency exchange on profits; mining taxes in the primary countries in which NEM and AU do business; the timing lag between high Gold Prices and ramped-up production – you name it. It's also worth remembering that, despite being primarily gold miners, AngloGold and Newmont also have sizable business segments in non-gold metals like copper, silver and uranium, all of which also impact revenues and, thus, share prices. [Ed. Note: Anglo also retains a small "hedge book" of forward gold sales, albeit drastically reduced and likely to fall further in 2010...]

Still, that doesn't make the complete disconnect of correlation any less surprising to new investors. The moral of the story is: If you plan to invest in a Gold Mining stock, make sure you aren't using it as a direct proxy for Gold Prices. As you can see, the two are not always equal, and sometimes, they don't even travel in the same direction.

It's best to think of miners as a leveraged play, and choose your investment options accordingly.

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Gold Investment Strategy

Diversification is key to making the right size of Gold Investment...

LAST YEAR was great for gold and gold investors, but it will shine more brightly still in 2010 according to the World Gold Council.

The non-profit, mining-backed research and marketing body believes Gold Investment demand in particular has much further to go.

Here Jason Toussaint, the WGC's New York managing director of Exchange Traded Gold – which manages and promotes the World Gold Council-backed exchange-traded gold products worldwide, including the world's second-largest ETF product, the GLD Gold Shares Trust – speaks to Hard Assets Investor about why.

Hard Asset Investor: In your most recent report on Gold Demand Trends, the World Gold Council identifies two key drivers of the gold market in 2010: higher Gold Investment demand out of the US and Europe, and higher jewelry demand out of India and China. Which of these two factors is the stronger influence on today's market?

Jason Toussaint: If we look at historical figures, we see that jewelry consumption leads all sectors, in terms of tonnage of demand. That will continue going forward, and jewelry would have the higher impact.

That said, it might be worth noting that when we speak about the jewelry market in the non-US or the non-Western markets, the differentiation between a jewelry purchase for adornment and for investment is very great. It's very difficult to say that someone in the Indian gold market who's purchased gold jewelry is doing so exclusively for the jewelry aspect and not for investment, because there's a very liquid two-way market in that around the world.

The bottom line is, and the common thread here is, gold is seen as a long-term store of wealth, which is keenly important in today's markets.

HAI: We've heard a lot about China and India's appetite for gold jewelry. But are we also seeing any recovery in jewelry demand in the US and Europe?

Jason Toussaint: Absolutely. I think the larger impact on jewelry demand is generally volatility and the pace of change in the Gold Price, and not necessarily the notional figure at that point in time. In other words, we typically see when there's a steep run-up in the Gold Price, that tends to suppress jewelry demand. And when we have a leveling out, or a less rapid increase in the Gold Price – as we enjoyed in the first quarter – jewelry demand tends to come back. And that's absolutely what we saw this past quarter.

HAI: We've seen much weaker Gold ETF buying this quarter on a year-over-year basis. Granted, 2009 was an exceptional year, where investors rushed to ETFs in record numbers. So is that the only reason we're seeing a decline in Q1 2010? Or are there more factors at play here?

Jason Toussaint: Well, it's very difficult to point to one factor and say that that is the exclusive factor behind gold ETF demand. But I think we did see somewhat of a slowing of interest. And what could have happened is rebalancing activity. A lot of investors rebalance on a tax-efficient basis by selling gains and offsetting them with positions that have losses, and gold was a very strong performer in 2009.

Maybe people and investors said, "We're done. We want to see what happens." But particularly toward the end of the first quarter, and certainly very recently, there was another dramatic uptick in demand for Gold ETFs.

So I think we're seeing a large paradigm shift in the view of gold by investors from what used to be a strictly safe-haven view, and using it as a short-term tactical portfolio tool, to a much more longer-term focus on portfolio diversification and wealth diversification. Investors are generally holding their gold for very long periods of time. We hear from the investment advisory community that most advisers who have recommended gold for their clients are recommending a 5% allocation. Now as an organization, we don't recommend gold in any percentages; this is simply what we're hearing from the marketplace.

HAI: But what happens when the global economic picture starts to improve substantially? Do you think people will still view gold as that long-term portfolio asset, or will investors switch back to a tactical view once the markets appear to improve?

Jason Toussaint: I think that it will be continuously viewed as a strategic asset. It's not as if it's a binary question. Gold is generally viewed now as a buy-and-hold type of investment asset. And I think what lends the biggest backdrop to that is the events of 2008. Investors were caught so off guard, and there was such a huge cyclical decline across all markets – but gold was one of two asset classes among all of them that had positive returns that year. The key message is, if you get it wrong, and risk hits you on the downside, then gold is there to preserve at least a portion of your portfolio's wealth.

I like to tell investors that when gold is your No.1 portfolio asset, that's the time when you need it to be. When was the last time you assembled a portfolio and said, "Every one of these positions is my No.1 performing asset"? It doesn't work that way. The concept of diversification is still key.

So I think if we look at the peak in mid-2007, there was a general laissez-faire approach to market risk, because we had it good for so long. In the seven-year equity bull market from 2000, there was a tendency to take portfolio risk for granted, and to not understand that returns are generally normally distributed.

HAI: Do you think investors, as a whole, have reset their expectations of risk and return as a result of the crisis?

Jason Toussaint: Absolutely, and particularly on the institutional side. What is the fundamental purpose for defined benefits plans? It's to ensure that they have assets to fund future liabilities. And gold, in particular, has a great way of protecting wealth in periods of negative surprise.

Gold is the type of portfolio asset where you set it and forget it. I like to say, the time to buy insurance is not when your kitchen is on fire. That's the important point. If we went long when assets are rising, and then went back to cash or some short-term holdings while they fell – unfortunately, most investors don't have the luxury of day-trading their portfolios. Certainly pension funds don't.

So from a strategic, long-term asset allocation perspective, think of it as a policy benchmark for a pension fund or an institutional investor. Gold Investment does have a place in there.

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