Gold - casually mention the word to a
group of investment-minded friends and colleagues and
watch as it inspires a visceral reaction, since people
either love gold or hate it; there aren't many who feel
ambivalent toward it. Those who love it realize that
gold has been the ultimate store of wealth for over
3,000 years, while various paper currencies have come
and gone. Those who hate it maintain that gold is an
"archaic relic", no longer relevant in a world
where the majority of business transactions are carried
out with a few clicks on a computer keyboard, and money
is nothing more than a digital entry on a computer.
Or is the antagonism toward gold because they realize
that a rising gold price makes them uncomfortable? Subconsciously
the disbelievers may sense that a rising gold price
is like an economic barometer forewarning of a coming
Since 1971, when Richard Nixon ended convertibility
of the US dollar into gold, various myths and misconceptions
have been circulating, influencing people's opinions
and resulting in a number of unfounded myths that have
dogged the yellow metal.
MYTH - Gold is
The importance of holding precious metals
in an investment portfolio has been largely forgotten
during the equity bull market of the past twenty years.
Holding precious metals in a portfolio can provide three
distinct benefits: speculative gains, hedging and wealth
preservation. However, many investors and their advisors
focus only on the speculative aspect and treat gold
as if it was an industrial commodity like copper or
Traditional asset allocation theory, as represented
by the investment pyramid, advocates higher risk, less
liquid assets at the top, with lower risk, more liquid
assets at the bottom. Typically, precious metals and
commodities are placed at the top of the pyramid, while
cash equivalents are at the base. While placing commodity
futures contracts, options and exploration junior mining
companies at the top of the pyramid is appropriate,
fully allocated physical bullion should form the foundation,
While futures contracts, options and mining equities
can provide leveraged speculative opportunities, they
belong in a different asset class along with percentage
holdings based on individual investor objectives and
risk tolerance. They also carry much higher risks, and
have been known to decline to zero. Unallocated bullion,
like pool accounts and certificates, can form part of
a portfolio's cash component, but should not form the
foundation as they may become illiquid and, in certain
circumstances, could lose their value completely. Fully
allocated, segregated bullion is not someone else's
promise of performance, nor is it anyone else's liability.
It cannot decline to zero.
An effectively diversified portfolio should contain
at least five percent in physical bullion held on a
fully allocated, segregated basis at all times. This
asset allocation model provides effective hedging, benefiting
the investor because precious metals have a negative
correlation, or inverse relationship, to traditional
financial assets like stocks and bonds. Holding bullion
reduces portfolio volatility and improves returns during
normal market conditions. During periods of economic
stress, bullion acts as portfolio insurance, growing
in value and effectively offsetting losses in the other
asset classes. For added protection in turbulent economic
times, bullion allocation should be increased to 10
- 20 percent.
MYTH - Central Banks no longer need
to hold gold and have sold off their holdings!
The Central Bank of Canada has ignored thousands of
years of monetary history and bought into the "archaic
relic" view, and has sold off nearly all the gold
it held in its foreign exchange reserves. From a peak
of 1,023 tonnes in 1965, Canada now holds only 100,000
ounces of gold valued at $45 million. This places it
in 77st place, below third-world developing countries
such as Bangladesh, Guatemala and Tunisia.
This sell off has contributed to an impression within
Canada that other central banks are also divesting themselves
of gold, but statistics compiled by the World Gold Council
show that official global reserve holdings of 36,575
tonnes in 1971 have declined by only 0.4 percent annually
to 31,736 tonnes in July, 2004. Gold sales by Canada,
Australia, Britain and Switzerland, among others, were
offset by gold purchases in France, Germany, Japan,
China and Taiwan. Recently Argentina has been buying
10 - 12 tonnes per month to shore up the value of its
The Bank of England also accepted the "archaic
relic" label, sold half of its gold reserves at
the very bottom of market, and purchased interest-bearing
US treasury bills. Since then, the US dollar has lost
about 30 percent against the British pound, while gold
has increased by approximately 30 percent in British
pounds. Gold and silver have successful 3000-year track
records as portable stores of wealth, whereas paper
money does not. Although the US dollar is considered
by many to be the most stable currency, it has lost
approximately 80 percent of its purchasing power since
gold convertibility was eliminated in 1971.
MYTH - Gold is not a good investment!
Although fully allocated gold bullion
is not an investment per se, its long-term performance
has been more than commensurate with risk. Gold's decline
from its 1980 peak is often cited to support the "poor
investment performance" myth but, when measured
from a cyclical peak, any investment will take many
years to break even. The DOW did not recover to its
1929 high until 1954. By that time, many of its original
stocks had completely disappeared and were replaced
by alternatives. Fifteen years following the peak of
Japan's NIKKEI, it has only achieved approximately 25
percent of that peak.
In fact, on a cumulative basis since 1971, gold has
outperformed the DOW. Gold's rise from $35 per ounce
in 1971 to its recent $415 level amounts to a 1,086
percent increase versus the DOW's 1,046 percent increase
from 868 to 9,950 today. In the past four years, gold's
performance has dramatically outperformed that of equities.
While gold has increased 63 percent, the DOW has lost
13 percent and the tech-heavy NASDAQ is down 62 percent.
As for the future, gold is poised to outperform equities.
The DOW:gold ratio has averaged 10:1, peaking at 44:1
in 2000. Today, the average has dropped to 24:1 and
has decisively broken below the 200-day moving average.
A number of respected analysts expect to see a 1:1 DOW:gold
ratio, as occurred in 1980 and in 1935. The only question
that remains is will the ratio be 1:1 at 6,000, 4,000
MYTH - Precious metals are too volatile!
myth that gold is volatile simply does not stand up
to scrutiny. While mining stocks, particularly junior
exploration companies, are highly volatile, gold bullion
is not. According to a study by the World Gold Council,
the volatility of the DOW during the past ten years
has been 16.13 percent as compared to 12.55 percent
The volatility of mining stocks, particularly during
bull market cycles, can afford tremendous trading profits.
It is critical to have either a knowledgeable advisor
or to become proficient in technical analysis. Some
traders use trading profits to augment their bullion
MYTH - Mining stocks and bullion are
equally effective as portfolio hedges!
One of the most prevalent misconceptions
is that holding gold mining stocks is preferable to
owning bullion. However, the decision between gold mining
stocks and bullion is not an "either/or" decision.
Each asset has a different place in the investment pyramid,
representing different objectives and different risk/reward
relationships. Fully allocated bullion is used for long-term
wealth preservation because it maintains its purchasing
power and also acts as a hedge against economic crises.
Mining stocks, precious metals mutual funds, futures
contracts and options are used for both speculation
and investment during bull market cycles, but are subject
to market, management, financial, labour, geopolitical,
environmental and hedging risks.
Another misconception is that bullion is positively
correlated to mining stocks with both rising and falling
in unison - it is not. In the crash of 1929, Homestake
Mining, the largest and oldest gold producer in North
America, initially declined with the rest of the equity
market, but recovered while equities continued down.
Unless investors were both knowledgeable and had staying
power during that time, a hedge using mining stocks
would have failed. In the crash of 1987, mining stocks
declined more than general equities. Bullion, however,
maintained a positive position with less than 20 percent
During bull markets, mining stocks initially tend to
outperform bullion. However, as the bull market progresses,
bullion tends to outperform mining stocks. In the 1970s,
Homestake achieved a 900 percent increase, whereas gold
more than doubled that level at 2,300 percent. When
a rising gold price signals a non-confidence vote in
the country's fiat currency, the flight to its safe
haven status can result in dramatic gains.
MYTH - Mining stocks are more liquid
The belief that mining stocks offer
superior liquidity over bullion is another popular misconception.
Total aboveground gold is estimated at $1.7 trillion.
On an average day, a net of $6 billion of physical gold
is traded among the members of the London Bullion Marketing
Association in London alone. This does not include gold
futures trades on the commodities exchanges, or retail
investment purchases, or jewelry. On the other hand,
the total market capitalization of all global mining
stocks is less than $150 billion. The most liquid and
largest gold-producing company in the world is Newmont,
with a market capitalization of about USD$20 billion.
It trades about $200 million shares per day, representing
a turnover of about one percent of its market cap. Even
if this turnover rate is applied to all mining stocks
it would equate to about $1.5 billion, or one-quarter
of the gold bullion traded in London alone.
In addition to higher liquidity due to higher market
size and higher trading volume, gold bullion is accepted
as payment globally, whereas a mining stock certificate
would have little if any value in many parts of the
world. There is a difference between liquidity and convenience
in purchasing the investment. The purchase of physical
bullion may be somewhat time-consuming and inconvenient
for a retail investor compared to placing a trade for
mining stocks. However, as the precious metals bull
market progresses, new investment vehicles will come
to market that will provide equal convenience for purchasing
bullion as is currently available for mining stocks.
MYTH - The price of gold and silver
has been in decline due to lack of demand!
With all the attention on the latest high-tech
stocks, the price declines in gold have been attributed
to lack of demand. Surprisingly though, gold, has experienced
supply deficits for more than a decade amounting to
over 22,000 tonnes.
How can the price of a commodity decline in the presence
of a supply deficit?
Basic economics tells us that a supply deficit causes
prices to rise, but that hasn't happened in the case
of precious metals. The fanfare that always accompanies
central banks sales gives the impression that these
sales have made up the deficits. However, net central
bank sales only account for a small part of the deficit.
The balance of the deficit has been made up through
the practice of leasing, creating an artificial supply
that acts to suppress prices.
Central banks lease out gold to bullion banks at low
interest rates. Bullion banks, in turn, lease the gold
to mining companies and hedge funds that sell the bullion
and invest the proceeds in higher yielding investments.
Calling this practice leasing is a major misnomer. In
the case of the mining companies, it is more accurate
to refer the practice as "covered short selling"
and in the case of the hedge funds, it should be called
"naked short selling". In both cases, the
artificial supply that suppresses prices will be a major
contributor to the coming price increases as these entities
are forced to buy bullion at market price to mitigate
escalating losses and cover their short positions.
Although there is some controversy about the total
amount of leased gold, the estimates are between 192
million and 800 million ounces. Any sharp price rise
in either metal will have a slingshot effect, caused
by a massive short-covering demand that cannot be filled
with even several years' worth of mine production. This
will greatly magnify any increased investor demand and
put extreme upward pressure on prices.
For 3,000 years precious metals have maintained their
purchasing power and have been the most liquid, universal
form of money throughout the world. Since 1971, both
the Canadian and US dollar have lost approximately 80
percent of their purchasing power while gold has enjoyed
an increase. In 1971, for example, a new car could be
purchased for $3,500 (100 ounces of gold) and a starter
house in the suburbs for $35,000 (1,000 ounces of gold).
Today, 100 ounces would buy two new cars and 1,000 ounces
would buy two houses or an estate in the country.
If investors take the time to examine why they have
a negative bias towards gold, and can accept that what
they believe to be true may be myth or misconception,
even the naysayers may realize the important contribution
precious metals can make to a portfolio and how they
can both increase and preserve their wealth in the coming
Nick Barisheff is the President
of Bullion Management Services, manager of The Millennium
BullionFund. For more information on investing in bullion
please visit the resources section at www.bmsinc.ca
estimates and projections ("information") contained
herein are solely those of Bullion Management Services
Inc (BMS) and are subject to change without notice.
BMS is the investment manager of The Millennium BullionFund
(MBF). BMS makes every effort to ensure that the information
has been derived from sources believed to be reliable
and accurate. However, BMS assumes no responsibility
for any losses or damages, whether direct or indirect
which arise out of the use of this information. BMS
is not under any obligation to update or keep current
the information contained herein. The information should
not be regarded by recipients as a substitute for the
exercise of their own judgment. Commissions, trailing
commissions management fees and expenses all may be
associated with an investment in MBF. Please read the
prospectus before investing. MBF is not guaranteed,
its unit value fluctuates and past performance may not