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It's Now Easier to Invest Bullion! 11/19/4


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#1 TTHQ Staff

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Posted 19 November 2004 - 02:50 PM

BEING STREET SMART
____________________

Sy Harding



IT’S NOW EASIER TO INVEST IN GOLD BULLION! November 19, 2004.

Until this week buying gold bullion meant dealing with such problems as taking delivery, assuring safe storage, providing insurance, and potential problems with buying and selling in a timely manner.

To overcome those problems, as well as significantly increase their profits (or losses), gold traders use derivatives in the form of leveraged ‘futures contracts’ to make their trades. Since futures trading in commodities (coffee, corn, pork bellies, gold, crude oil, platinum and the like) is an extremely high risk undertaking, most participants are those who have inside information, like the commodity producers themselves, and professional international traders.

Public investors normally invest in the gold sector by buying the stocks of gold mining companies, and the gold mutual funds that invest in those stocks.

However, this week it became much easier for ordinary investors to buy, sell, and own gold bullion itself, without having to take delivery.

After more than a year of getting the details worked out and obtaining approvals, the World Gold Council’s exchange-traded-fund (ETF), Equity Gold Trust, began trading on the NYSE under the symbol GLD. Unlike most exchange-traded-funds, which invest in stocks, GLD buys gold bullion, and sells shares in that gold to investors via the exchange-traded-fund. The shares can be bought and sold through any stock brokerage firm. The gold will be stored and guaranteed by HSBC Bank USA. Each share of the exchange-traded-fund is designed to be worth one-tenth of an ounce of gold. So, with gold trading at $440 an ounce, each share would be worth approximately $44. If gold drops to $400 an ounce, each share would also decline 10%, to roughly $40. If gold rises to $500 an ounce, the shares in the ETF would rise to $50.

The year-long lead-up to the introduction of the ETF has been one of promotional activities and bullish claims to hype interest. For instance, it has been widely claimed that the introduction of the ETF will create a large new demand for gold and therefore drive the price of gold much higher.

You may want to keep the sources of the promotional excitement in mind when considering GLD as a method of investing in the gold sector. The World Gold Council is headquartered in London, and is an association of the world’s leading gold producers, “dedicated to the promotion of gold”. Do not expect a balanced outlook for gold or the Council’s new exchange-traded-fund, from that source. The other main source of information on GLD so far has been the TV financial shows, always eager for a story they can hype to build excitement.

The big question is whether investors interested in gold, who have been investing in the gold sector by utilizing gold stocks and gold mutual funds, should shift to investing in gold itself via the World Gold Council’s new offering.

Here is an important fact to consider. When gold is rising in price, gold bullion itself does not have near the potential for profits that are available from gold mining stocks and the gold mutual funds. That’s because the profits of gold mining companies, as with any company, depend to a significant degree on the price they can get for their product. An increase in the price of gold not only increases a gold mining company’s top line (total sales), and bottom line (profit) but also increases the value of its gold reserves (the gold it still has in the ground).

The result of this multiplying effect from an increase in the price of gold, is that gold mining stocks, and therefore the mutual funds that invest in them, tend to move almost twice as much as the underlying gold bullion.

That is not theory, but fact, and is easily verified. For instance, gold began a new bull market in 2000. From its low in 2000, gold bullion has risen in price from $253 an ounce to $444. That’s a nice rise of 75% in four years, an average annual gain of 15%. However, in the same period of time, the XAU Index of Mining Stocks has gained 163%, or an average annual gain of 27.4%. The Rydex Precious Metals fund, a typical mutual fund that invests in gold mining stocks, gained 184% over the same four-year period, for an average annual gain of 30%.

Let’s look at the other piece of hype, that if a lot of investors pour money into the World Gold Council’s new exchange-traded-fund GLD, it will significantly increase the demand for gold, and drive the price of gold higher. To begin with, it would take one heck of a lot of small investors buying one-tenth ounce shares of gold to have such an effect on the price of gold. But even if it happens, it would be even more bullish for investments in gold mining stocks and mutual funds, since they tend to move twice as much on a percentage basis as the underlying gold.

So while being able to easily invest directly in gold bullion may be a sexy idea, and the hype surrounding the introduction of GLD may push you in that direction, gold mining stocks and gold mutual funds should continue to be the investment of choice for the gold sector.

Meanwhile, it wouldn’t be nice to hope that hoards of investors do pile blindly into gold bullion via the new ETF, without any such analysis, and drive the price of gold higher for those of us who stick with the gold stocks and mutual funds. So we won’t.



Sy Harding is president of Asset Management Research Corp., DeLand, FL, publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market.