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An Investment in Gold and Growth

Welcome to the first issue of the Dick Davis Investment of the Week. To start things off today, I’d like to focus on an aspect of investing that I find particularly interesting, and that editing the Dick Davis Digests gives me a bit of an advantage in observing: trends. If you...

Welcome to the first issue of the Dick Davis Investment of the Week. To start things off today, I’d like to focus on an aspect of investing that I find particularly interesting, and that editing the Dick Davis Digests gives me a bit of an advantage in observing: trends.

If you have young kids or grandkids, you know that the trendiest thing from preschool to high school right now are “SillyBandz,” which are essentially rubber bands. They come in shapes like hearts and unicorns and Justin Beiber, and you wear them on your wrist. They’re tradable, cheap and inexplicably trendy.

Of course, trends aren’t just for kids; adults are equally swayed by what’s popular. Trends have an overwhelming influence on everything from what color cars we buy (white and silver are most popular this year) to what we eat (think Omega-3s, antioxidants, cupcakes and kombucha … whatever that is). If you think you’re immune to the influence of trends, just think back to the hairstyle you were wearing in the ’70s or ’80s.

Investors, too, are far from immune to the powers of trends. Of course, when it comes to investing, trends can be both friend and foe. The main difference is timing. Notice a trend early, and it can make you a lot of money. Jump on the bandwagon late, and you’re liable to lose a bundle.

It’s a tricky balancing act, but it’s no reason to ignore trendy investments. Just remember to temper your enthusiasm for the trend with perspective, common sense and, preferably, a time-tested system. A system with rules that you formulate ahead of time—and then stick to when emotions run high—can mean the difference between a healthy profit and a painful loss.

When you have a solid investing system in place, including a hard and fast sell discipline, you can invest in trends without losing any sleep at night, knowing your system will make sure you get out with your shirt still on, no matter what. And when things go right, you can do a lot better than that. Because once they’re under way, trends tend to last longer, and go further, than we expect. (Just look at cupcakes.)

Today, there are a few major trends driving stocks. One is the ongoing migration to cloud computing. Cloud computing stocks stumbled a few weeks back, but, as I said above, trends tend to persist longer than expected. The industry itself is still strong, and I think the trend probably is too.

China’s ascendancy is a mega-trend that’s boosting everything from small-cap Chinese start-ups to multinational corporations like Wal-Mart (WMT) that are expanding into China. Natural gas is trendy too; longer-term, the shift to generally cleaner energy is a major trend. DVDs by mail is a mature trend, streaming video is a newborn trend. Computerizing medical records is a mini-trend.

But probably today’s biggest, most popular, most headline-getting trend is the glitteriest: gold.

Gold prices have been rising pretty consistently for a decade, and the trend accelerated seriously in the wake of the financial crisis. This year, European debt crises, concern about the U.S. national debt, and other factors propelled nominal gold prices in dollars, euros and rupees to new highs. JPMorgan made national news when it reopened its gold storage vault under Manhattan, citing customers’ increased desire to hold physical gold.

Investments tied to gold have also had a banner year. Gold miners, gold futures, gold exchange-traded funds (ETFs)—even silver- and copper-related investments—have all seen investor interest, and thus prices, soar. The three ETFs that hold physical gold (GLD, IAU and the newest, SGOL) are all up over 25% so far this year. And among the experts who contribute to the Dick Davis Digests, interest in gold has increased noticeably, with newsletters that never used to mention the stuff now recommending multiple gold investments. As one editor wrote recently when he decided to buy a gold stock he’d previously passed over:

“What has changed, in this case, is my perception of the world’s demand for precious metals. Gold is at an all-time high and, for the time being, the gold bugs may have it right.”

In October, another convert wrote:

“I know that I have been avoiding the gold market like the plague in this letter. My fear has been that the Fed could kill the whole gold rally by announcing that it was going to raise short term rates back towards more normal levels. [However, now] I can say that I am having my doubts that this is going to happen as soon as it should. Therefore I think a limited investment in an ETF that seeks to use derivatives to achieve 200% returns on the movement in the price of gold could prove to be profitable—at least in the short term.”

Obviously gold prices themselves explain many of these bandwagon-jumpers. But probably equally important is gold’s trendiness. It’s hard to ignore a trend that everyone else is talking about … it can make you feel like a third grader with no SillyBandz to trade. It can be especially hard if you make your living by writing about investing… and have to face subscriber questions like “Why are you ignoring blank? It’s up blank percent in the last month!”

Well, I like to think that I have a sort of birds-eye-view of trends, thanks to the hundreds of newsletters I read. And I think it’s times to take a step back and remind ourselves of some fundamental, un-trendy truths about gold. Here they are:

A Few Things to Keep in Mind About Gold

1) The price of gold is set by supply and demand—it does NOT reflect the “inherent” value of gold.

2) Accordingly, the price of gold CAN go down. The frequent characterization of gold as a “safe haven” tends to ignore this fact. An investment that can lose a lot of its value, quickly, is not what I’d call a safe haven. Gold loses value when demand for it decreases.

3) … And someday it will. Like any price that is ruled by supply and demand, the price of gold will only keep going up as long as people keep offering more for it. At some point, the people who want to keep buying gold at the current price and above will be outweighed by the people who want to sell it—we call this inflection point the “point of peak perception.” This point occurs during times of euphoria: when everyone (seemingly) loves an investment so much that there’s (practically) no one else left to fall in love with it… and thus no one left to buy it, at higher and higher prices. The general feeling toward gold today looks a lot like euphoria.

4) Finally, remember that gold, unlike the stock of a company that makes and sells things, cannot grow. If you buy a bar of gold today, it will still be a bar of gold in six months (in fact, because gold is inert, it will still be a bar of gold in 1,000 years). Companies, on the other hand, can (and generally should) grow over time, by making more, selling more, acquiring other companies, etc. So, ideally, when you buy a stock, you’re buying the potential to own more in six months than you’re buying today. Gold, on the other hand, is always going to be the same exact thing—the only thing that changes is what people are willing to pay for it.

Still, you shouldn’t let any of those facts stop you from investing in gold if you want. As I said above, investing in trends can be a great way to make money—and they tend to last longer and go further than we expect. Just keep those four important truths about gold in mind, stick to a proven investing system, and try and keep some perspective.

If you do decide to invest in gold, I’d advise choosing an investment that offers exposure to gold prices as well as growth potential. Gold miners are the obvious choice here: they own gold, so you will too, but they’re also companies with potential for growth. Look for miners increasing production to ensure you’re getting that key second component. One such miner was recommended in the Dick Davis Investment Digest back on October 20, and is up 10% since—largely due to gold mania but also thanks to a solid third-quarter earnings report, a bright production outlook and an increasing dividend. Below is part of the original recommendation by Nathan Slaughter, editor of StreetAuthority’s MarketAdvisor:

“I initially recommended Goldcorp, Inc. (GG) in April 2009 for a host of reasons. Among them: rock-bottom extraction costs, a growing reserve base, a flexible balance sheet, a strong production forecast and, of course, the likelihood of rising gold prices. What has changed since then? Two things. First, gold prices have ascended from below $1,000 per ounce into uncharted territory above $1,300 per ounce. Second, the company has cut the ribbon on its Penasquito mine. …

“Appetite for gold has been stoked by the European debt quagmire and fresh evidence that the U.S. economy is beginning to stall. Investors looking for a reliable store of value have been pumping money into ETFs such as SPDR Gold Trust. Inflows have been particularly heavy in India, with assets more than tripling over the past year. According to Bloomberg, these funds now have 2,096 tons of gold bullion in their vaults—more than China and Switzerland combined. …

“And all this has happened in a deflationary environment—prices could really heat up once inflation takes root. On that front, the Fed has dropped hints that another round of quantitative easing could be on the way. Running the printing presses again will only weaken the dollar and make gold shine even brighter. And few miners will benefit like Goldcorp, which not only has one of the industry’s widest profit margins, but also its strongest growth forecast. Production is expected to rise 58% over the next five years (which means last quarter’s sales of 598,000 ounces could eventually be 945,000 ounces). If you think gold is headed higher, then GG is the stock to own.”—Nathan Slaughter, StreetAuthority Market Advisor, 10/12/10

Thanks for joining me for the first Investment of the Week. I hope you’ve enjoyed it. I’ll be back next week with another idea!

Wishing you success in your investing and beyond,

Chloe Lutts

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.