Gold shines as asset prices rise ever higher

Making money in financial markets is simple in principle. You buy when prices are cheap and starting to rise, and sell when they become obviously too expensive. At the moment investors face an unusual situation with almost all asset prices being highly priced.

That is what happens when the price of money, or interest rates, is kept artificially low by central banks for a long time. No wonder the Dow Jones Industrial Average hit a record high almost daily at the moment, or that house prices in the major cities of the world are so high, or that bonds are richly priced with ultra-low yields, indeed negative yields in some countries.

You are very hard pressed in such an investment environment to spot anything that looks cheap, let alone that has just started to rise, and therefore presents an attractive investment opportunity.

Step forward precious metals. Gold was the first asset class to recover from the global financial crisis and jumped in price up until it topped out at US$1,923 an ounce in 2011, when investors began to gain confidence in the economic recovery.

A number of the top technical chartists I follow say there has just been a technical breakout in the gold price. That is to say you have the classic investment opportunity of catching a solid asset class with its price just coming off the floor.

Now there are a few caveats to that. This is not a market insight that will definitely make you profits in the next week or two, or even a few months. It is more a multiyear observation useful in the long-term allocation of capital. What will become painfully obvious to many investors currently feeling rich on the back of record highs in US stocks after a very long, and therefore highly vulnerable, bull market, is that stock prices can go down as well as up.

Indeed, the Federal Reserve’s interest rates hike last week could later prove to be the straw that finally broke this camel’s back. If you look at recent hard data coming out of Wall Street, it has all been rather weak, it is only the soft data of market sentiment that looks strong.

Basically increasing the cost of finance is a burden on business, and it contracts as a consequence and that produces a contraction in the wider economy, or recession. The US stock market is richly valued at the moment for an everlasting bull market.

Does it make sense to stay invested? Not in my humble opinion.

But it is true to say that you do not have many other options. Really only precious metals and by extension other parts of the commodities complex like oil seem cheap.

So what exactly do you buy this summer to maximise this investment opening? Physical gold, preferably stored in a very safe geographic location, is probably the least risky and least volatile option.

However, silver prices are leveraged against the price of gold and tend to advance by about twice as much when precious metal prices move up.

Shares in the producers of gold and silver are another way to leverage the rising price of precious metals.

In a nutshell, the cost of extracting precious metals remains fairly fixed, so these companies get a disproportionate boost to their profits from a boost in the price of their finished product.

For gold producers there are exchange-traded funds (ETF) like GDX to consider for the larger producers and GDXJ for the junior companies. Interestingly, the GDXJ index for junior gold stocks was reorganised at the end of last week because it just could not handle the huge amount of money now chasing this sector. In some cases GDXJ owned as much as its mandate allowed of an individual company and it could not find enough junior gold companies in which to invest its ever-growing capital inflow.

Ironically this temporarily depressed the sector as GDXJ dumped some smaller stocks to buy more highly valued companies.

The same could be said for SILJ, the silver producer’s junior ETF that has also become depressed in price while it seemingly awaits a similar shake-up.

This sort of ETF reorganisation is surely another indicator of what is coming in the sector.

All that it takes is for investors to wake up and smell the coffee in Wall Street and their game is up; then the buying will start in earnest in precious metals.

Buying some gold as an insurance policy for stormy days ahead never looked wiser. Indeed, gold has outperformed the S&P 500 so far this year.