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Is it better to buy Gold Bullion or Gold Shares?

Commodities / Gold & Silver Stocks Mar 19, 2010 - 03:26 PM GMT

By: Julian_DW_Phillips


Best Financial Markets Analysis ArticleGlobal equity markets have changed over the last three years, investor capacities and capabilities have changed as have interest rate patterns. This makes it incumbent upon investors to re-examine this question from the ground up.

The value of Dividend Yields

In the days of yesteryear, long-term investors bought shares because of growth potential and in particular for the income they would earn from shares and its growth. The share price would then focus on dividends and potential dividends rising or falling in line with such growth or lack thereof.   Capital appreciation would follow. Present and future Dividend Yield was usually tempered [as was the share price] in the booms and busts, by relating it to the average 5 to 10 year fixed interest rate yield. This was because one had to ask, ‘what would the advantage be in investing in risky equities, when one had the benefit of risk-free fixed interest securities’. The potential of the equity shares could then be related to the state of the economy insofar as it related to interest rates.

We now maintain that such value assessments should come out from yesteryear and find their place in today’s portfolios. With the ‘baby boomer’ generation reaching retirement now, their Pension funds have to switch to paying out regular amounts to this group, while the current far smaller group of future pensioners are not contributing sufficient amounts to these funds, to allow their payments to service this growing bulge of pensioners now retiring. The shortfall will have to come from the income stream of investments.

“Earnings don’t Count”

Then the optimism of the early eighties grew and a culture of ‘earnings don’t count’ came onto the scene. The workforce contributions to future pensions was far more than enough to service existing pensioners and still contribute to the capital for investment into the funds. This allowed institutional investors to ignore a clear income stream to investors and to focus entirely on capital growth reflecting the growing size of the investment. This assumed that share prices would reflect this growth and make any income stream irrelevant. Investors have bought into this and did so right through the summer days of the markets from the early eighties to 2007. In many, many cases this led to price earnings ratios to rise to well above 30 times.

If we refer back to the Earnings concept, this meant that the company’s share price was discounting 30 years worth of earnings a very rosy view of the future and potential growth. Ah, you may well counter, the value of each share would rise higher than any such concept, so would justify such a view. And if we lived in a world where summer was perpetual, this would be true. But the winter of August 2007 changed all that.

We now need a share for all seasons and that brings us back to scene where shares should be bought that will do well in bad days and grow in value [followed by price], in the dark days. We come back to not just the sound concept of ‘total return’ but how to benefit from a growing income stream that leads to share price growth, making ‘total return’.

Investor failure

In 2007 the quality of good companies was sound and measurable, but even those share prices tumbled alongside most markets, Why? Share owners found the need to liquidate portfolios to cover cash gaps elsewhere. Leveraged markets came under the most pressure as bank loans became harder to keep and prices fell across the board forcing more liquidation. Prime asset such as the housing markets were the focal point of price collapses. Bear in mind the replacement costs of those houses did not fall. All these prices fell because of investor failure brought on by credit failure, not because value fell away from good companies. And such investor failure and potential investor failure has not gone away. Should we now lurch into a double-dip recession it will hammer values once again!

Please note that equities as a class of investment fell right across the board including gold shares after August 2007. The gold price was rising, but investors did not have the capacity to ensure gold mining share prices would rise. Yes, gold Exchange Traded Fund share prices rose alongside the gold price, but that was because there was no corporate risk between the gold price and those shares.

Shares that will survive such a winter and whose price will grow are out there and are in the gold market, at the right price.  

Shares ‘for all seasons’ are out there

In short, good shares that should be in a portfolio have to pay for their keep. [We have our own favorites in the Gold Forecaster newsletter we issue on a weekly basis.] We will say now that that excludes a large number of sound, large companies that don’t put investor interests and requirements first. And it is those companies that do badly when winter sets in.

Gold mining equities ‘feel’ only the average gold price over its entire financial year. Yes, they tend to discount the gold price during that year, even ahead of the average gold price. Now that there will be a greater emphasis placed on dividend streams, only when a company decides its profit distribution policies at the end of its financial year will the investor taste any benefit.  These can be greater than the gold price, as certain select gold mining company share prices can outrun the gold price. So the emphasis on choosing well cannot be stressed enough. It starts with defining just what you want from the gold share investment.

The benefits of gold bullion

In many investors’ minds gold bullion is the only investment in extreme times, because of its portability, un-printability, etc. It will be ‘the ultimate bubble’ in the days to come, as George Soros said recently. But there are several categories that gold bullion fits into before that.

  • As a portfolio diversifier.
  • As a ‘counter to swings’… in all currencies.
  • As a corporate-risk free investment.
  • As a thermometer-like measure of the state of the global economy.
  • Bullion ‘feels’ the rise and fall in the gold price instantly.

In each of these roles it can serve investors well as seen since 1999. For those who amazingly cling to the idea that it gives no [income return] we point to its exceptional ‘total return’ in that period when it rose from around $275 to today’s $1,125.

Its one disadvantage is that it is vulnerable to government interference and confiscation. Gold miming companies are vulnerable to government nationalization and taxation. In rare situational cases gold bullion can escape such government interference.

Which shares and what qualities do the right gold shares have?

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By Julian D. W. Phillips
Gold-Authentic Money

Copyright 2009 Authentic Money. All Rights Reserved.
Julian Phillips - was receiving his qualifications to join the London Stock Exchange. He was already deeply immersed in the currency turmoil engulfing world in 1970 and the Institutional Gold Markets, and writing for magazines such as "Accountancy" and the "International Currency Review" He still writes for the ICR.

What is Gold-Authentic Money all about ? Our business is GOLD! Whether it be trends, charts, reports or other factors that have bearing on the price of gold, our aim is to enable you to understand and profit from the Gold Market.

Disclaimer - This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold-Authentic Money / Julian D. W. Phillips, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold-Authentic Money / Julian D. W. Phillips make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold-Authentic Money / Julian D. W. Phillips only and are subject to change without notice.

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