Wed Feb 05 2014
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Investing In Bullion–Without The Bull

It’s not just the paranoia of Fed-bashing, “hard money” zealots: Inflation really does pose a threat this year.

After the yellow metal’s brutal pounding in 2013, gold bugs are starting to feel vindicated. New data suggest that the inflation beast is stirring from its long slumber, which means the classic inflation hedge of gold could be on the verge of a comeback.

Inflation expectations, as measured by the difference between yields on 10-year nominal Treasury notes and Treasury Inflation Protected Securities (TIPS), rose last month to 2.28 percent from a low of 2.10 in the preceding month. The increase represented an eight-month high.

On January 16, the US Bureau of Labor Statistics reported that the cost of living in the US increased by the most in six months. The consumer price index rose 0.3 percent in December, the most since June, following no change the prior month. The news immediately pushed up the price of gold—and there appears to be further price upside ahead.

In a January 17 article in our affiliated advisory Inflation Survival Letter, my colleague Richard Stavros examined how some of the largest and most influential investment management firms are sounding the alarm over inflation.

To be sure, job creation is tepid, labor costs are low and energy prices remain in check—all arguments against a rampant pace of inflation. But the fact remains: The US Federal Reserve and central banks in other countries are now tightening the monetary spigot, putting an end to the days of “easy money” and ultra-low interest rates. The bill for this extraordinary worldwide stimulus is about to come due.

And even though the recovery isn’t as strong as anyone would like, it is real and gaining traction. On January 30, the US Commerce Department reported that the US economy grew by an unexpectedly robust 3.2 percent in the final quarter of 2013.

The time to purchase inflation hedges is now, before the rest of the investment crowd belatedly tries to get in on the action and makes them more expensive.

Solid Gold Plays

Gold ended 2013 with a 28 percent loss, but it’s ready to regain its luster as investors embrace a commodity that’s historically been a safe haven during crises and inflationary conditions.

Conventional wisdom dictates that portfolios should contain at least 5 percent to 10 percent of gold as protection against any downturns and fluctuations. As this aging bull market enters its fifth year, we expect at least moderate corrections in the global equity markets in the coming months.

These two gold plays are poised to shine:

•    If you’re more comfortable with a fund, we recommend SPDR Gold Shares (NYSE: GLD), the largest gold exchange traded fund (ETF) backed by physical holdings of bullion.

•    Our favorite gold-related stock is Goldcorp (NYSE: GG), an Inflation Survival Letter portfolio stalwart and one of the world’s fastest-growing gold miners.

GLD is the most popular bullion ETF, as well as the most liquid physically backed gold offering available. Launched in 2004, GLD was the first gold ETF available in the US. GLD seeks to replicate the performance, net of expenses, of the price of gold bullion.

Although the fund’s expense ratio is relatively high at 40 bps, it trades at a heavy volume of more than 9 million shares a day and boasts $ 42.02 billion in assets under management.

GLD had a rough 2013, posting a 28.3 percent loss. Investors last year pulled $ 25.1 billion out of the ETF. So far this year, the fund has experienced $ 299.1 million in outflows. But we think gold has bottomed—and this flagship gold ETF is ready to bounce back.

If you prefer a stock with greater potential upside, consider Goldcorp. Headquartered in Vancouver, British Columbia, Canada, this senior gold miner boasts operations and development projects throughout the Americas. During past inflationary environments, gold mining shares as a whole rose faster than the inflation rate.

Goldcorp enjoys many advantages over its more volatile rivals, including production growth combined with low cash costs, a strong balance sheet, and operating jurisdictions that are politically stable.

Goldcorp’s operations include five mines in Canada and the US, three mines in Mexico, and two in Central and South America.

The company’s existing assets, combined with several expansion projects in the pipeline, lay the groundwork for substantial production growth for the rest of the decade.

Goldcorp has compensated for lower gold prices by launching several new, cost-efficient projects, including Cerro Negro in Argentina; Éléonore in Quebec, Canada; Cochenour in Ontario, Canada; El Morro in Chile; and Pueblo Viejo in the Dominican Republic.

Goldcorp currently boasts one of the lowest all-in production costs of any primary gold producer in the world, at around $ 1,150 per ounce. As of this writing, the price of gold was hovering at around $ 1,240/oz.

In January, Goldcorp announced record gold production of 767,700 ounces in the fourth quarter, resulting in 2013 gold production of 2.67 million ounces, an increase of 11 percent over 2012. Management projected gold production in 2014 to grow 13-18 percent, to between 3 million and 3.15 million ounces.

Many analysts predict that the price of gold will rise to at least $ 1,400/oz this year, which means Goldcorp’s low production costs would pay off in a big way.

Goldcorp currently pays a dividend yield above 1.9 percent with a historically low dividend payout ratio below 30 percent. Since 2009, Goldcorp’s dividend has increased by a whopping 233 percent. That said, management also has demonstrated its commitment to reinvesting profits for future growth.

China’s Thing for Bling

In addition to increased interest in gold as an inflation hedge, other sanguinary trends will lift Goldcorp and GLD in 2014 and beyond.

Notably, China’s rising middle class is spending more disposable income on luxury items, including gold jewelry and other status symbols.

China’s economic growth should remain on track in 2014, putting more money into the pockets of a population that increasingly has a thing with bling. Individual Chinese also are turning to gold not just for ornamental purposes but also as a storehouse of value in uncertain times.

Indeed, China has overtaken India as the world’s largest purchaser of physical gold. As the chart below shows, Chinese demand for gold outshines the rest of the world.

China’s purchases of gold climbed 30 percent, to 996.3 tons, in the 12 months through September 2013, while sales in India rose 24 percent, to 977.6 tons, according to the London-based World Gold Council. India was number one in 2012. Each country buys more gold than the US, Europe, and the Middle East combined.

Nearly 80 percent of the annual gold supply is turned into jewelry. China’s growing embrace of jewelry will significantly boost gold demand—and the fortunes of both GLD and Goldcorp.

Remember, diversification is crucial to any investment strategy. As we enter the second month of 2014, consider rebalancing your portfolio to accommodate the likely economic, business and market trends of the coming year. One of those likely trends is higher inflation, accompanied by rising demand for gold. Hedge your bets accordingly.

For further guidance, consult Inflation Survival Letter and its weekly e-zine, Survival of the Fittest.

John Persinos is editorial director of Personal Finance and its parent website Investing Daily.

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