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Let’s Get Real: Why You Must Own Precious Metals

by David Smith, Money Metals:

It can be difficult, even for dyed-in-the-wool perma-bulls to hold onto precious metals, let alone buy more. We see the Dow trading above 20,000 (placing this into perspective, is that since 2000, the Dow is up around 65% versus gold’s 300%), gold and silver currently languishing below multiple “resistance” points; suspended just above a couple of “support” lines. For long-suffering holders, it feels like the fabled Sword of Damocles dangling over their head, suspended by that proverbial single strand of hair.

If you fit the above description, the following chart should provide good cheer. You’ll notice that since 1925, a few years before the Great Depression, up until the current day, financial assets (paper) – bonds, large cap stocks, and derivatives – have never been more overvalued in relation to metals and minerals, than they are now.

What you must realize, is that if you truly desire to “insure” some of your own financial assets against a major turn of events with the potential to heavily damage their value, then it is imperative to seriously consider a position in the asset class which above all others, tends to move in direct opposition to them.

The “kicker” is that, at such undervalued rates, when – not if- the metals return to the norm, that movement, plus the almost inevitable overshoot, makes it close to a lead pipe cinch that you’ll be looking at a big profit on your purchase as well. The metaphorical rubber band stretches just so far, then reverses. And that class has at its apex, gold and silver.

It’s not just an article of faith, but rather a proven fact that the more out of favor a category is, the less downside risk and the greater upside appreciation potential there will be. Markets move up on sustained buying – in the earliest stages rising on a so-called “wall of worry” – wherein in spite of all the naysayers’ protestations, the price of the item in question continues to move higher. Later as the trend matures, you’ll see stronger upward movement with less and less objection from observers ,and more writers agreeing with the move. This signals that “more people are joining the parade”, with less watching. Finally, almost everyone is “all-in” with lines around the block as late-comers frantically try to buy what little remains of gold and silver in retail hands – but we are far from that situation today. Sure it’s “easy” to buy the Dow above 20,000, and as it rises on reduced volume, large numbers of IRA investors are doing just that. But big money is seldom made this way.

The five categories of a gold miner’s ore body
Whether in production, or on a path toward it, a mining company needs to determine via expensive drilling, magnetic testing, laboratory sampling and computer modeling programs, how much gold-bearing ore they have, and how likely what they possess – or think they hold – can be produced at a profit. The most well-known of formal reporting methods is the Canadian resource classification reporting methodology called the (National Instrument) NI 43- 101 Report.

The two categories – and within them, five sub-categories, in order of descending likelihood of being recovered and sold at a profit are: Reserves: Proven and Probable; Resources: Measured, Indicated, and Inferred. A company will not generally undertake to build a mine/mill unless they have identified reserves that should grant them a 7-10 year production life. Resources sound great, but they may or may not ever “pan out”. The following chart shows that for the past 7 years, even as exploration expenditures increased, success in locating gold in “unreported discoveries” languished. In the millions of ounces (Moz) “reported category” – the amount has cratered.

Less than a year ago, industry CEOs were talking about world gold production peaking “sometime during the next 10 years.” Now we’re seeing that Reserves – the most accurate estimate of economically-recoverable gold, have declined 40% since 2011, and stand at levels not much higher than was the case in 2005, when the gold price was moving into the first solid phase of its long-term advance. A recent Bloomberg chart shows that recoverable (newly-discovered) gold has dropped fully 85% since 2006!

Keep in mind that a gold mine is a “wasting asset.” Every ounce produced that is not replaced by discovery of another economically-profitable ounce, takes the operation one step closer to the end of its productive life. Looking again at the discovery and expenditure chart demonstrates that as things now stand, the drop in Reserves – ounces most likely to be recovered at a profit – is taking place at warp speed. The much less-reliable Resources category – has also fallen sharply. Indeed, Indicated/Inferred figures themselves often end up being little more than hope and hype. And you can’t “take that to the bank.”

In Europe, one week made a huge difference in gold demand
Recently, during one week, the European trading venue, Xetra Gold ETF (Deutsche Börse AG) saw an inflow in excess of one-half billion dollars, the largest such movement in 5 years! This amount was 10 times more than GLD, the U.S. ETF equivalent registered during that same week. Other European metals’ ETFs saw increased activity as well.

In this space a year ago, I discussed Rich Dad Robert Kiyosaki’s way of looking at things, using his analogy of a gold coin. Whereas most people see just the front (obverse) and back (reverse), Kiyosaki sees a third side – the edge. Only by looking at an issue from the vantage point of the edge, will you be able to “see both sides of the coin”.

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3 comments to Let’s Get Real: Why You Must Own Precious Metals

  • Ed_B

    Well, here we go again with yet another article that poses that one can EITHER own PMs OR they can own paper-based investments. Nothing could be further from the truth, folks, because it is entirely possible to own both at the same time. Not only is it possible but it’s a damned good idea!

    Whether one is buying PMs or stocks, the method of acquiring them is more similar than it is different. There are two powerhouse concepts of which any investor, large or small, can make good use.

    The first of these is asset allocation. This means that one divides their money into different investments, including stocks, bonds, real estate, commodities (PMs are part of this group), and cash / cash equivalents (money market accounts, very short-term bonds, savings accounts, and physical cash). Once one has set an allocation, they can then invest their money according to their plan. An extremely simple allocation plan could be to divide their money among these assets in equal amounts. For the sake of simplicity, let’s say that between their retirement plan at work and their own personal savings, they have $100,000 to invest. The simple plan means that they would put $20k each into each of these 5 investments. The gold and silver portion could be divided equally between these two metals, so $10k each in gold and silver. Currently, this would amount to about 8 ozs. of gold and about 550 ozs. of silver. After 4-6 months of this, they would look at their holdings and sell off some of what has done well while buying some of what has lagged. This keeps the portfolio in balance at the 20% each allocation setting. This should be reviewed annually to see if they still want this allocation.

    The second of these is dollar cost averaging, which means that they invest about equal amounts of money over time. These investment additions usually occur at some regular interval, such as every 2 weeks, monthly, or quarterly. By doing this, assets are acquired regularly and at favorable prices because investing a fixed amount of money means that when share or oz. prices rise, fewer shares and ozs. are purchased and when prices fall, more shares or ozs. are purchased. This will bias the investment towards lower costs and higher shares or ozs. Over time, this builds up a very nice portfolio that was acquired at a very fair price.

    In no case does the wise investor “go all in” with their money because no matter how good something looks to us, we can always be wrong and choose the wrong place to invest our money. This decision is critical in life and not to be bungled. To prevent that, we hedge our money such that part of it is just about always rising to compensate for losses elsewhere. I too wish that I could always buy assets that only go up but that’s not a viable investing plan. The world is far too complex for that to happen more than occasionally. Most of the time, there will be other factors out there that cause what once looked like a great investment to become a rather poor one. If there is anything that I have learned about investing over the past 40 years, it is that the comment that was once made about “nobody knows nuthin” is true more often than not. So, rather than rely on emotions, create a solid saving / investing plan and stick with it with only minor tuning on an annual basis.

    Because of all this, I have avoided devastating losses over the past several years. This allows me to be a lot more comfortable with investing and growing my wealth slowly over time. This is a good feeling that helps keep me in the investing game, rather than being squeezed out by bear markets that can create staggering losses if one is not very careful.

  • JMiller

    I like how precious metals bulls, when comparing the return of gold to the return of stocks, forget to include the dividends for stocks in their calculation, which is what Mr. Smith “forgets” to do. Also they like to use a start date more favorable to gold, that being the year 2000. Instead let’s start back in 1971 when the U.S. went off the gold standard. The average annual total return for the S&P 500 since 1971 is about 10% per year while the average annual return for gold is only about 7.5% per year. Over the long-term the total return for stocks is greater than the total return for gold.

  • cmore

    I dont see where the article mentions holding metals exclusively. Spreading risk is the best way to investing. Relative to owning PM’s an associate once said, “why buy the egg when u can own the goose?”
    The

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