Hidden Risk Hinders Gold

 | Apr 10, 2013 | 12:30 PM EDT  | Comments
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Extensive money printing (QE programs) have had many traders stocking up on gold via ETFs, ETNs, physical coins & bars and through shares of precious metal mining companies. This urge to own hard assets in a soft money environment makes sense on an intuitive basis.

  

The first two of those statements appear indisputable. Is gold really an inflation hedge? That is subject to debate.

Gold peaked in 1980 at about $850 per ounce. Gold bottomed in 2000 at about $250 per ounce. Annual inflation in the early 1980's was running in the double-digits. The 1990's calmed down but still saw significant price increases each year. 

Underperforming by 207.8% over a 20-year period would strain the patience of even the most ardent "gold is an inflation hedge" advocates.

When gold touched it 1980 high pundits were calling for $2,500 to $3,000 per ounce. Thirty-two years later they're still waiting. We've been hearing $5,000 to $10,000 numbers thrown around recently. Will those predictions prove more accurate? Only time will tell.

Betting on gold to hold value versus 'full faith and credit' fiat currencies does seem appealing. What are the hidden problems with employing at least some portion of your portfolio in this way?

Recent history shows at least some custodians of your warehoused gold to have been unreliable. Commodity brokerage firms MF Global and Peregrine Financial both failed to protect customer interests in physical gold 'safeguarded' by them.

If you correctly bet on gold going up you still may never even see your original stake returned, let alone any paper profits. Speculators were willing to risk price fluctuations. They didn't know they were also subject to outright theft of their property.

Many traders today play gold movements with ETNs (Electronically Traded Notes) without knowing these have bigger risks than simply metal price action. These ETNs are unsecured obligations of their issuing financial sponsors.

It's no surprise the list above was compiled by issuers of safer Gold ETFs (Electronically Traded Funds).

Physical delivery of Krugerrands, American Eagle gold coins and or bullion bars and holding them in your own safe seemed to avoid the custodial problems. Now, word from ZeroHedge.com confirms that Chinese companies have been actively promoting the sale of assorted counterfeit gold plated items 'for legal purposes only'.

Click here and here for the original articles reporting on this very disturbing practice. The fakes are of such good quality that even professionals have been fooled.

This action raises questions about the authenticity of every existing coin and bar in both private and even government vaults. The only way to confirm purity is to open the packaging and drill into the cores of each individual item.

This is expensive and decreases the value of the underlying gold even if everything checks out. Who will buy your personal stash without knowing if it is the real thing?

The Sept. 11, 2001 terror attacks permanently changed airport security. The known counterfeiting of well-respected gold coins and bars has now forever damaged the ability to sell gold without huge, value-sapping authenticity testing.

I used to favor shares of mining companies as a safer, liquid, back-door play on rising inflation. Worldwide political forces and heavy government debt have been catalyzing repudiation of long-term contracts and unilateral nationalization of foreign assets.

The good of days of paying the promised royalties to less developed nations while mining their natural resources appears to be coming to an end. This explains what look like bargain prices on industry leaders like BHP Billitron (BHP), RIo Tinto (RIO), Freeport-McMoran (FCX), Newmont Mining (NEM), Barrick Gold (ABX) and others.

All forward estimates may be shot to hell in the political climate that looms just over the horizon. For mining companies with overseas operations, past performance may not be a good gauge of future profitability.

For the individual investor gold is looking a lot less attractive than it did originally.

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