Here is Hoenig's Missive on Gold....
Thursday September 20, 4:44 pm Eastern Time
SmartMoney.com - Tradecraft
All That Glitters
By Jonathan Hoenig
AT A TIME when nothing seems certain, there are a few things you can count on that never change. From spending time with friends to seeing a good movie, some pleasures just don't go out of style. They're timeless. Personally, I'm a guy who loves the simple things. Happiness to me is takeout sushi, a hot bath and thick flannel pajamas.
To that end, now might be the time to think about another timeless investment: gold. Long the perennial loser, gold has fallen off most investors' radar screens as anything more than a historical oddity. Those who follow or invest in gold or precious metals are generally thought of not just as ``bugs,'' but as hysterics — the lunatic survivalist fringe of the investing world.
Even for the few who actually own precious metals or their related stocks, it's usually a small allocation that serves as nothing more than a portfolio ornament. A percent here, a percent there...never enough to actually make an impact on one's overall return. It's just something to hang on the tree.
We first talked about precious metals a few months back as being one asset class that has historically been negatively correlated with both equities and the U.S. dollar. Indeed, it's a relationship that has served gold investors well this year. Even before last week's atrocities, precious-metals stocks were soundly outpacing the market. With both gold and silver up sharply since the World Trade Center attack, that dramatic outperformance has become even more pronounced. The Philadelphia Gold/Silver Mining Index has now bested the S&P 500 over the last 24 months. Even more impressive has been the AMEX Gold Bugs Index, which is a basket of gold companies that don't hedge their exposure to metals prices. Doubters cast off this performance as a short-term phenomenon, but from my perspective there's no evidence the strength can't continue.
Either directly or through mutual funds, most people I know own shares of large-cap stocks like General Electric (NYSE:GE - news), Merck (NYSE:MRK - news), Oracle (NASDAQ:ORCL - news) or Exxon Mobil (NYSE:XOM - news). But I would be hard pressed to think of one who owns Barrick Gold (NYSE:ABX - news), Placer Dome (NYSE:PDG - news), or some of the smaller metals companies that dot the American Stock Exchange. But if you're looking for an alternative to equities or the Standard & Poor's 500, look no further. Gold is the Eddie Vedder of the investing world.
The lack of public interest is probably best illustrated by the mutual-fund assets that are allocated toward precious metals — or more precisely, the lack thereof. Analysts at Morningstar track 551 funds categorized as ``large-cap blend,'' 462 called ``large-cap growth'' and 352 considered ``large-cap value.'' Only 21 funds, roughly less than half of 1% of their entire universe, are mandated to invest in gold or precious metals. The dollar amounts are even more telling: Large-cap growth funds have assets of some $609 billion. Metals? Less than $2 billion. To me, this smells like opportunity. As we've often discussed, it never pays to run with the herd.
What interests me most is illiquid markets. Based on current demand and available supply, gold is highly liquid, but that delicate balance could easily be upset if even a small fraction of the trillions of dollars in mutual funds came sloshing into the precious-metals sector. Could you imagine the effect on prices if the appetite for gold, silver or other precious metals was ever even close to what the interest is tech shares was just 18 months ago? $300 gold would be no question. $400 would be a more likely possibility. Warren Buffett was buying silver a few years back when it was near $5 an ounce...couldn't value players make an argument that today's price of $4.50 seems like a relative bargain?
Although it's the precious metals' technical strength that interests me most, there are a number of fundamental arguments for why they deserve a place in every portfolio. To start, gold's historical function as a store of value makes it, in contemporary parlance, highly visible. It's a commodity that has been worth something literally forever. When Jesus was born, for example, the three wise men didn't bring him a basket of AMEX:QQQ or shares in JDS Uniphase (NASDAQ:JDSU - news), but myrrh, frankincense and gold. It's a tradition that carries through to this day. At some weddings they toss rice. At others they break a glass. But I've never been to a wedding where the bride and groom didn't exchange rings that were, without exception, made of a precious metal like gold. Of course, how much gold is worth is often in flux. But whether it has worth is never a question.
With everyone looking to ``bottom fish'' these days, you could make a very plausible argument that gold is just plain undervalued relative to other assets. Even with a recent spike, gold trades for less than it did in 1985. The S&P 500, on the other hand, down roughly 34% from its all-time high, still trades at roughly the same place it did back in late 1998. Cheaper, no doubt, but a fire-sale bargain? Not in my book.
A final factor in my bullishness is the fact that the world's central banks, and especially the Bank of England, have regularly been selling gold for the last couple of years.
It was back on May 7, 1999, in fact, that the BOE announced plans to sell more than half of its gold reserves — a move that almost immediately sent the metal down more than $38 to $250 an ounce, a new 20-year low.
Now, governments tend to be bad traders to begin with. But the market isn't stupid, and the fact the Bank of England has been so public about the time, price and quantity of its sales gives one even more reason to believe they're selling the low. With all respect to Her Majesty, thebest trading strategies are usually the ones you don't splash all over the front page of the Financial Times. Indeed, gold bullion has climbed steadily ever since the initial tumble, up approximately 16%. I would not be surprised if the metals continued to rally through March of 2002, when the final auction is scheduled to occur.
Maybe this is the top for gold. Maybe I'm completely wrong. But as we often stress, what matters most in trading isn't what you buy, but how you buy. Proper risk control, position size and timing are ultimately the biggest determinants of success. Good technique insures that when you are wrong, you get bruised, not broken.
But you can't play the long side of stocks that keep going down. So if what you're doing isn't working, try something that is.
The pundits may laud what gold lacks: namely dividends, earnings or profits, but those were never a factor when they were snapping up tech shares just a few months back. And until the market gives me reason to think otherwise, I believe metals represent a low-risk long in a environment where political and economic uncertainty has quickly become the status quo.
Jonathan Hoenig is portfolio manager at Capitalistpig Asset Management, a Chicago-based hedge fund. At the time of writing, Hoenig's fund was short shares of General Electric and Oracle. |
