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Banks Stocks vs Gold StocksPeter Forth The economy is in trouble. Scandals and bailouts of major institutions occur on a nearly daily basis. It is the day of the Goldbug, or is it? From a fundamental analysis point of view there are a lot of reasons why bank stocks should be losing value. Toxic debt made up of defaulting mortgages has lead to billions of dollars of write-downs so far, with a strong likelihood of billions more to come. In fact the size of these write-downs compared to the book value of the banks even puts the solvency of many of them into question. Even people who have doubted the solvency issue in the past have to admit that the failures of Northern Rock, Bear Sterns and IndyMac lend credence to the argument that not all is well. Goldbugs are generally people who follow a more contrarian point of view than the average investor or mainstream analyst. Many of them have been warning of these problems for years now. Their reasoning is that as the system becomes more unstable the price of gold and by extension the price of stocks that mine gold will go up. A combination of flight to safety and a reaction to federal money printing to fund bailouts should drive the price of gold stocks in an upward direction for as long as the crisis continues. Sounds good, sign me up. I'm a Goldbug now. But wait let's take a look at what has happened since the crisis really got into high gear 6 months ago:  This is a chart of the Gold Miner's index (XAU) against the Banking index (BKX). Although the banking index initially underperformed the XAU, in the last month or so a downdraft in the XAU and an updraft in the BKX has brought the two to within a few percentage points of each other! In the end, the average Goldbug contrarian investor might as well have been in Goldman Sachs or Merrill Lynch during the biggest series of bank and market crisis we've seen since the seventies. They called problems in the market correctly but have failed to profit from their prognostications. But wait, this is only a 6 month window, what if we go further back to before problems came to public attention?  This two year chart shows that the XAU is definitely performing better than the banks. But in spite of this, gold investors are not exactly striking it rich either. In fact after two years of watching many of their predictions come true, buy and hold gold stock investors are now back to exactly where they were two years ago with a 0% gain (and at a net loss after inflation). So gold stocks haven't done well. How about gold itself?  In spite of the recent correction in gold prices, people who invested in pure gold as opposed to the miner stocks remain up nearly 35%. From a purchase point two years ago, at nearly any given point in time in the last two years, an investor in gold has been ahead of an investor in gold stocks. Many of the gold analysts that predicted our current macroeconomic dilemma so accurately are now saying that this is just the beginning. I would suggest that while their diagnosis has been correct, their cure up until now has not been ideal. Unlike in the more distant past, gold stocks have not provided a multiplier gain to gold's earnings. The best method for riding out our macroeconomic problems over the last few years has been a combination of being short bank stocks and long gold bullion. There are some reasons to believe that the current correction in gold stocks is a bit overdone and we are currently going into a seasonally strong time for them so I wouldn't recommend eliminating them from your portfolio. That being said until fundamental conditions change, or until technical analysis shows an upside breakout in the behavior of the gold mining stocks, gold bullion and market short positions should make up a significant portion of one's portfolio for the duration of this crisis. Aug 10, 2008 Peter Forth is President of 4th Systems Inc. and creator of the StockReflex stock market replay simulator. You can watch the video, download a trial version, or buy the replay simulator here. Part video game, part learning tool, StockReflex helps you refine your technical analysis skills and amass trading experience without financial risk. 321gold Ltd |
