Century Management Portfolio Manager Answers the Question: What's Your Gold Worth?
Gold prices have set new record highs this year. Why did this happen?
The current operating procedure of the Fed targets interest rates, specifically the fed funds rate. It adds (buys bonds) or subtracts (sells bonds) liquidity to make sure the rate stays at 0%. It has had to buy bonds to increase liquidity this year and that excess liquidity, as always, shows up first in a higher price of gold.
If gold has been setting record highs, why have the majority of gold stocks lagged over the past year?
Sometimes these stocks act like equities, sometimes they act like gold. Generally speaking, gold stocks reached a high in 2006 when the implied price of gold in the stock was HIGHER than the spot price. Now the opposite is true: the implied price of gold in the average gold stock price suggests a nearly 40% discount in the spot price of gold. If the spot price stays near this level (low-to-mid $1,700′s), the gold mining equities will eventually rise as that discount disappears.
With gold prices so high, what do you think will happen next?
Flip a coin: gold could go (much) higher or (much) lower. Refer to question one. As long as the Fed targets interest rates, and unless the economy picks up to a considerable degree, the trend suggests an increase in excess liquidity to maintain a 0% fed funds rate, which is likely to lead to an increase in the price of gold, or at least a price that ranges between $1,550 and $1,850. Alternatively, if the Fed begins to target prices (gold or commodities, but not the CPI), the price of gold will go to the price level they target.
With gold prices elevated, some investors are looking at silver. What are your thoughts on silver?
Gold is a monetary metal, meaning that although it is a commodity, its importance is that is has little utility, but great scarcity. This is not the case with silver, which USED to be considered a monetary metal, but since the 1870′s is really now considered a commodity. However, in times of great monetary upheaval where the central banks lose control over stabilizing the currency, silver will revert to acting like a monetary metal. That is what has happened over the past year or so. Typically, when the market considers silver a monetary metal, it will trade in a range of 12oz to 50oz of silver per ounce of gold; when the market considers it a commodity, it will trade in a range of 50oz to 100oz per ounce of gold.
How does recent market volatility play into your thinking?
I believe the stock market’s volatility is directly related to the volatility in the price of gold (and thus the compounding of errors by the Fed). A higher gold price suggests higher inflation. This signal will be discounted immediately in the multiples of the market, although it will take many years to show up in the Fed’s Consumer Price Index statistics. After the market discounts the new, higher expected inflation (like it did in the third quarter of 2011), it then ‘resets’ its price according to earnings and the increase therein. Importantly, the market only discounts the new, higher price of gold once. Any additional discounting will require a new, higher price of gold.
Stephen W. Shipman, CFA, is a senior portfolio manager and a senior equity analyst at Century Management. Mr. Shipman’s thoughts in this paper concerning gold, silver, and the stock market are solely his own and, of course, there can be no assurance with regard to future market movements. Past performance is no guarantee of future results. Furthermore, it cannot be assumed that any recommendations or characteristics discussed herein will prove to be profitable. Century Management reserves the right to modify its current investment strategies, techniques, and opinions based on changing market dynamics or client needs.
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