Five reasons to cool it on gold stocks

Independent Investor themselves trying to buy into the sector. Of course, we have seen this movie before: sometimes the sector keeps rallying after a big gain, sometimes not. We are here to throw a bit of cold water on the faces of gold bugs, though: Here are five reasons why you might want to temper your enthusiasm for the sector after its big run.

Spot gold is up about 16 per cent this year. Certainly, a decent performance in a short time. Compared with gold stocks, however, 16 per cent is pretty lame. XGF, ishares S&P/TSX Gold Index ETF, is up about 63 per cent this year. Now, most investors realize that gold stocks have more ‘torque’ than gold bullion when things are going well, so this outperformance is not surprising. But while you build yourself in a lather on gold stocks, don’t forget torque goes both ways: in a decline, we would fully expect stocks to drop at a much faster rate than bullion.

Gold prices went up 12 years in a row, and then declined 28 per cent in 2013, 2 per cent in 2014 and 10 per cent in 2015. Gold stocks fared far worse, generally, than bullion. Thus, what is occurring this year might simply be a strong bounce after three years of weak performance. We might be wrong, of course, but gold may have been simply oversold and under-owned by fund managers, who needed to buy to get positions back in line. Once they have done this, the rally might stall.

It is generally accepted now that U.S. interest rates are going to rise this year. Higher rates make alternative (non-gold) investments more attractive, and of course also drive the U.S. dollar higher. Since gold is priced in U.S. dollars, this makes the metal more expensive for everyone else in the world, and demand could wane.

Gold itself pays no dividends, of course, and actually costs you money to hold and insure. Gold companies, at least some of them, still pay dividends, but many have been cut or eliminated altogether. Thus, as the market rallies (and as interest rates rise) there is a big opportunity cost in owning the gold sector. Gold at- tracts all sorts of crazies, who expect governments to implode and gold to be the new medium of exchange. Sure, there is a possibility of this, but there was also a possibility of this 30 years ago. How long are you willing to wait for it to occur? Conspiracy theorists claim that governments and central banks are manipulating gold. Suppose this were true, though: Would you not want to be on the side of the conspirators, who have unlimited time and resources? Why would you want to bet against them? If you spend any time on the Internet you will see some of the ads for the crazy side of gold investing. Ignore the theories: gold is an asset class, nothing more, nothing less. Like any other sector, it will have good years and bad years. We know some investors who have spent 30 years with gold buried in their backyard, waiting for the collapse of the financial system. Now, a healthy dose of skepticism never hurt anyone, but actions like that seriously hurt your long-term investment returns.

Whenever we pen a column referencing gold, it always gets a big response. We are not sure though why investors are so emotional towards the metal. Like a stock, gold doesn’t care where you bought it, if you made or lost money on it, or what you do with it. Melt it down, bury it, bank it — it just doesn’t care. Keep that in mind the next time you feel the urge to make too large a portion of your portfolio dependent on a single asset class.