Gold has definitely not lost its lustre

Here is an interesting question: what is the best-performing commodity of the last 20 years?

You might think energy – oil or natural gas. Maybe you think food – soybeans or pork or fertilizer. Perhaps you think something more unusual – lithium or diamonds.

All of those ideas are incorrect. The best-performing commodity of the last 20 years is gold. And that performance is despite gold’s reliable downturns – the yellow metal regularly gives up half its gains before advancing again.

So gold has outperformed all commodities (and most currencies) even though it moves two step forward, one step back.

The market knows this about gold. One of the reasons gold’s runs are so reliable is that when investors see the pattern starting again, they jump on board. The pattern, from peak to trough and back to peak, repeats roughly every seven years.

The strongest cycles last longer. With one of the longest and strongest bear markets having finally finished in January, gold is getting started on a new up cycle.

The chart below says it all. It charts the S&P/TSX Global Gold Index since 1970 and shows clearly the cycles we have gone through. I borrowed it from Sprott’s Thoughts, a great, free, twice-weekly commentary from Sprott Global Resource Investments (visit http://www.sprottglobal.com/thoughts/ to sign up).

bull-bear cycles chart
Bull-Bear Cycles Chart

The chart shows seven bull-bear cycles, though only the biggest three (three downs and two-and-a-bit ups) are highlighted.

Considering all seven cycles, the average decline was 67%. That means the 80% decline in the last bear market was worse than usual.

More important: bull-market gains have averaged 358% among those seven cycles. Recovering from the two cycles with the biggest losses (as highlighted on the chart) required gains of 760% and 607%.

To date in this up cycle, the S&P/TSX Global Gold Index gained 114% to its early August peak. The August correction has cut the gain back to around 80% today.

That means the gold index has to more than double from here to achieve the average gain of the seven bull markets, and it would have to quadruple from here to achieve a gain comparable to the last two big cycles.

That is a lot of upside.

There will be volatility along the way. You can see in the chart that gold never ascends in a straight line; it gains and corrects, then gains again. Success investing in the gold space requires:

1. Understanding the big picture. Gold is gaining today because interest rates are low or negative, corporate and government debt loads are high, high stock market valuations and bond prices have eliminated the classic “safe haven” investment options, the global economy is struggling to grow, and the fact that gold and gold miners missed the market’s long run means they are undervalued right now. Gold represents security and value.

2. Knowing that the price of gold will react to economic and political events. It will step back after going on a run. It will move sideways to consolidate support after a gain. As long as the pattern remains one of higher highs and higher lows, and the big picture remains gold positive, stay long.

3. Being ready to get out when things get crazy. Gold runs end. Rather than trying to pick the top, good gold investors get out before the frenzy. We are a ways from this in the current cycle and the characteristics differ each time, but if you are watching, there are always signs.

What exactly should a gold-interested investor buy?

There are options.

One is gold itself, either physical or paper. Physical you can keep under your bed or with a bank. Paper gold you buy through exchange-traded funds, where shareholders have exposure to the funds stock of physical.

A second option is major gold miners: Barrick, Newmont, Agnico Eagle, Goldcorp, Yamana, Kinross, and the like. You can choose one stock, getting direct exposure to its performance, risks, and dividends, or you can buy a basket of majors through an ETF. Miners outperform the gold price significantly, leveraging gold’s gains roughly three-fold in a rising gold market, which is why investors like this option.

A third option is to move down into the smaller companies: the companies exploring for new deposits or developing new mines. These juniors are much riskier – the deposit might not be there or the new mine might fail – but they also offer much higher rewards. In a good gold market, the average junior probably leverages gold’s gains six-fold, while the best of the bunch offer 10- or 20-fold multiples.

It is still early in this gold game. If you don’t have gold in your portfolio in some form or other, it’s time that you did.

Gwen Preston is the Resource Maven. In her weekly newsletter she explains the macro mining picture and chronicles her investments in the space. To sign up for a free trial, visit www.resourcemaven.ca