Is Gold About To Move Higher?

Source: Thinkstock

So far gold is one of the better performing assets year to date, with the SPDR Gold Trust (NYSEARCA:GLD) trading 7.5 percent higher. This is after we saw a severe bear market in the yellow metal that took prices down from over $1,900/ounce to less than $1,200/ounce.

Thus it should come as no surprise that the gold price is bouncing — even in a downtrend we find short term price appreciations. But is the downtrend over for gold, or is there another leg down?

Gold has been in a very long bull market for the duration of the 21st century. While many claim that it has ended this simply isn’t the case. Gold remains extraordinarily undervalued if we look at many historical metrics. For instance gold is at the lowest price it has been if we compare the value of the U. S. gold stockpile to the Federal Reserve’s monetary base. This means that hypothetically, if the U. S. were to back the dollar with gold, we would have to see a tremendous appreciation in the gold price in order for such a system to function smoothly.

Of course there is little likelihood that the U.S. will back the dollar with gold. However, we are finding more and more that foreigners are less willing to hold dollars and are increasingly swapping these dollars and dollar-denominated assets for gold.

Those that are buying large amounts of gold, however, are extremely patient, and they are more than willing to wait months, or even years, for the price to come to them. This could mean that the downtrend in the gold price has further to go. But then again we saw extremely strong buying from the Chinese at the $1,200/ounce level. Furthermore, the $1,270/ounce level acted as strong resistance prior to its breach a couple months ago. Now we are seeing buyers come in whenever we see downward price action towards that level. Those who are technical analysts know that a price level that was once resistance, once breached, becomes support.

While we could see a breach of the $1,270/ounce level, it will have to come in the face of tremendous buying from central banks and Asian and Middle Eastern investors with very deep pockets. Foreigners, especially in the east, want gold. We have seen tremendous central bank buying from Turkey to Russia to Kazakhstan over the past few years, and this buying goes unabated. While there is no official report of the People’s Bank of China buying, many gold market analysts believe that the PBoC has been the world’s largest buyer, and that its officials are afraid to announce the bank’s official holdings because of the effect it will have on the gold price.

We find that there are other forces supporting higher gold prices as well. Mining companies are having a very difficult time producing gold profitably at $1,300/ounce. While most large gold producers are announcing that they can produce the yellow metal at $1,000 – $1,100/ounce, when all is said and done most of these companies have razor thin margins with the gold price where it is. Many companies were forced to reduce their gold reserve estimates, meaning that they now have less in-ground gold that they can mine profitably. Kinross Gold (NYSE:KGC) has ceased production at one mine, and Barrick Gold (NYSE:ABX) put off construction of another. Most mining companies that paid a dividend last year cut it substantially or eliminated it altogether.

If the gold price remains low, I suspect more drastic action will be taken. More mines will be shut down, and this will reduce global supply.

With supply declining and demand rising, the price must rise, and now that we are consolidating the gains from the beginning part of the year I suspect that some of the larger buyers that I mentioned above will begin to push prices higher.

Gold is generally considered a good asset to have in a diversified portfolio. Here are two other assets that we had examined earlier that might be worth keeping in your portfolio to encourage diversification. Let’s review:

1. Foreign Assets

Many investors in the U.S. are U.S.-centric in their investing. We have better access to knowledge about U.S. companies as Americans, and we don’t have access to many foreign investments. However, there are a lot of excellent foreign investments. Many foreign stock markets are substantially cheaper than the S&P 500, and many of them also pay higher dividends. Furthermore, there are economies out there that have significant potential. For instance, many emerging economies have young, growing populations that are becoming more affluent and more productive as they get older.

Fortunately, we live in the age of ETFs and ADRs (American depository receipts), and these make it very easy to get access to funds holding several foreign stocks as well as individual foreign stocks. Investors have several options for gaining international stock exposure. For instance, a simple way to do so without taking on individual stock or country risk is to buy an ETF such as the Vanguard Total International Stock ETF (NASDAQ:VXUS). This fund is comprised of shares of the major companies traded throughout the world.

More aggressive investors –or those who have the time to investigate the benefits and detriments of investing in specific economies — have access to various individual country ETFs. For instance, one of the best performing stock markets this year is the Turkish Stock Market. Investors sold off Turkish shares last year in the wake of social unrest, and that created a great buying opportunity to invest in one of the world’s fastest growing economies at just 12 times earnings. Investors who are interested in Turkish stocks can conveniently buy the iShares Turkish ETF (NYSEARCA:TUR).

 

2. Income-Generating Assets

You need to have an investment that pays a substantial dividend. Income stocks will protect you in a down market, especially since the best dividend paying stocks are more defensive than your typical non-dividend paying stocks.

Finding a good high dividend paying stock is a little tricky in this low interest rate market environment. While there is no shortage of options, many companies pay high dividends because investors are concerned that they will not be able to sustain the dividend. Therefore, a good strategy is to look for companies that have stable businesses that are distributing a large portion of their profits to shareholders. The downside is that these profits cannot go into growing the business, but you can invest in growth companies with some of your other assets.

There are several good places to look for high dividend paying stocks. For instance, one option is the tobacco industry. These companies don’t have rapid growth, and it doesn’t have many outlets for investing their profits, and so it pays outsized dividends that exceed 5 percent. Other options include telecommunications companies such as AT&T (NYSE:T) and Verizon (NYSE:VZ), which have steady income streams and pay dividends that are substantially larger than your typical S&P 500 company. More aggressive investors can look into smaller, higher dividend paying companies such as the prison owners and operators – Corrections Corp. of America (NYSE:CXW) and the Geo Group (NYSE:GEO), which pay 6.3 percent and 6.9 percent dividends, respectively.

Disclosure: Ben Kramer-Miller is long Kinross Gold and owns gold coins.

More From Wall St. Cheat Sheet: