Best ways to obtain gold exposure

The purpose of this article is to go over the various ways one increases exposure to the gold commodity. Clearly while investing in gold producers is another method, I will leave that for other smarter individuals.

The hypothetical investment is a CAD$10,000 or US$7,400 investment in gold. With institutional levels of capital, there are other facilities to expose oneself to gold. For the purposes of this article I am assuming a US$1,220/Oz price and a 0.74 USD/CAD exchange rate.

The largest gold ETF is (NYSE: GLD) and they are massively liquid. The MER is 0.40%. The next largest gold ETF is (NYSE: IAU) and they charge an MER of 0.25%. I would recommend IAU strictly on cost differentials – both have volumes that are well above retail levels. In terms of security, the custodian of GLD is HSBC, while the custodian of IAU is JP Morgan Chase. My very unprofessional ranking would put the two level in terms of security, hence IAU is the winner on costs. At today’s gold prices, you would be able to purchase 6.06 troy ounces and pay about CAD$25/year for the warm and snuggly feeling of it being safe. Purchase and disposal costs the price of a trading commission. GLD and IAU are denominated in US currency.

In Canadian currency, the best bet (and indeed, the only bet) is (TSX: MNT) which carries the unique feature of being backed by the Government of Canada and at an MER of 0.35% (thus a yearly maintenance of CAD$35/year). Its only apparent drawback is liquidity – bid-ask spreads typically are between 10 to 20 cents so this is not a product where you would want to place market orders. Each unit is currently equivalent to 0.0107125 troy ounces of gold. Purchase and disposal costs the price of a trading commission. MNT is legally an exchange-traded receipt (ETR) and they do trade above and below net asset value like ETFs.

Another option is purchasing the physical product. These suffer from three issues – divisibility of the product, transport, and storage. Looking at online vendors such as Kitco, you can purchase a 100 gram gold product for CAD$5,430. Pretending you can buy CAD$10,000 of product would result in 184 grams of gold or 5.92 troy ounces, which is a significant spread off market pricing. Getting it in one ounce gold coins results in a net gold mass of 5.86 troy ounces. Also, once you buy the product, you also have to pay to have it shipped (CAD$30) and insured (CAD$40 for a $10,000 purchase), which also adds to costs. Finally, it has to be stored somewhere securely – a bank safety deposit box is CAD$65/year at RBC, but these boxes are not covered by any insurance if there were circumstances that would cause them to be stolen or destroyed. Also, if the gold is to be subsequently liquidated, there will likely be additional frictional costs.

As a result, I do not believe that physical storage of gold is feasible on the retail level beyond trinket sums of capital.

The last option is using financial derivatives to emulate the price of gold. The best option is to use gold futures on CME. These are extremely cheap to trade and are liquid products, but suffer from the primary drawback of being in lots of 100 troy ounces. Margin requirements to hold a gold contract (US$122,000 notional value) overnight is US$5,400, so from a capital maintenance perspective, if your desire is to hold 100 troy ounces of gold, I would prefer utilizing futures. Clearly this is not a viable option if one’s intention is to invest CAD$10,000 in gold.

Oil’s dead cat bounce, or the phoenix rising from the ashes?

Most of the oil and gas market has exhibited a two-day price rally from the previous month’s carnage in what can be considered a “dead cat bounce”. This is probably in recognition that Talisman’s acquisition implies that the rest of the oil that is stuck in the ground also has similar value despite the commodity price being lower than the cost to get it above the ground.

Some companies have reduced their capital budgets already – Canadian Oil Sands, Penn West, etc., have already announced capital expenditure reductions and dividend cuts.

The question here is how low crude oil will go before it truly bottoms. In 2009, it bottomed out at US$35/barrel, while today it is at around US$55/barrel. My gut instinct here says that we are very, very, very close to the bottom, but if you recall during the era of Bear Stearns’ near-bankruptcy (technically taken over by JP Morgan), it could take a few more months for this to play out to its ultimate bottom.

One thing I do know, however, is that the demand for liquid crude is not going away – airplanes are flying, people are driving their vehicles, and trucks are delivering cargo. The need for energy in the form of transport fuels is not going away anytime soon. A commodity can trade under the marginal cost of extraction for quite some time (this was the case for Silver post-80’s collapse) but continued demand will inevitably result in price rises unless if the extractors are operating as charitable organizations – most of them are currently at US$55/barrel!

For those with nerves of steel – buy oil

Most investors are likely aware that the price of oil has plummeted. This has taken a lot of equities down with it.

This is a very rough statement (some areas are cheaper to mine than others), but it is getting to the point (roughly US$75-ish) where a lot of tight oil (shale) is unprofitable to mine. This is where most of the oil boom from North America has originated. Heavy oil (oil sands) highly depends on where it is mined.

There are geopolitical games being played by OPEC and Saudi Arabia and the rest of the world. Commodities can trade under the marginal cost of extraction for awhile, but not indefinitely – especially in the case of crude oil, there will be demand.

The question is who shuts off the supply first? It will be the most insolvent high-cost producers, and then increasingly the more solvent unprofitable producers until the market supply decreases. Only then will we see oil prices turn around.

I do not believe a downturn in the oil commodity price will be sustainable for a long period of time in light of global demand still being high.

Decreasing capital budgets for 2015 will translate into decreased supply. However, this is not a speedy process. Most tight oil producers require a continual stream of capital to keep production levels stable and so I would guess some time in 2015 you are going to see a very sharp rebound in oil prices once enough supply has been shut off.

There is a cliche that markets go up slowly but crash quickly. With commodities, they go down slowly and rise quickly.

From my 50,000 foot perspective, there seems to be opportunity. I’m going to guess that low prices will persist until the end of this year. I do not see low prices continuing throughout 2015 unless if there is some sort of major global slowdown beyond what we already see in Europe and China (in the latter case, if you can call a decrease from 7% GDP growth to 5% GDP growth a “slowdown” when your GDP is already 9 trillion dollars, then it is a very odd definition of a slowdown!).

Picture yourself as some economic analyst in the People’s Republic of China with a mandate of securing global energy supplies. Right now you’d be licking your lips and looking at the various publicly traded entities out there. Your only fear is having governments refusing takeover offers out of national security concerns.

Broad energy ETFs (which also include refiners) that encompass this category are XLF, and VDE, but the exporation and producer index (XOP) has been significantly more impacted. XOP has an MER of 0.35%. The Canadian equivalent (and this ETF would provide eligible dividends as it would be from Canadian and not American sources) is XEG.TO and this ETF contains the usual list of Canadian energy producers (Suncor, CNQ, etc.) for an MER of 0.6%.

If you’re brave and have nerves of steel, buy oil. I can’t tell whether right now or the next three months or so will provide the lowest price point, but from a historical perspective, it is closer to the bottom than it was a month ago!

Price of gold

Gold got hammered today:

gold

What is interesting is that you’re going to start hearing people talk about marginal cost of extraction and about how that figure is a floor for commodity pricing.

It is not.

While marginal production cost is one component of commodity pricing, markets can go deeper below the cost of production because commodity markets measure instantaneous supply and demand. Eventually there will be some equalization but it does not have to be immediate – in fact, it can take a gut-wrenchingly long time to moderate to prices where costs are reflected.

I believe with the perception that gold is a safe haven from all the currency printing that is going on that there is a significant amount of the marketplace that is essentially going to be trapped in the commodity and the real question is going to be: when will this washout in-progress end? Markets usually trend longer and deeper than most people anticipate.

Most commodities (except for natural gas) are down across the board. If this trend continues, it will have a material impact on countries with commodity exposure – this includes Canada. As such, I am comfortable with my relatively large (2/3rds) US-denominated exposure. I also have no direct exposure to commodities.

Bitcoins

Bitcoins have been making some media headlines as of late because their chart recently went exponential:

Bitcoin

I wrote about Bitcoins quite some time ago and my analysis today is still the same – ultimately a currency is only as good as the confidence that people have in it, and digital currency has a drawback of counterfeit-style currencies (e.g. why not take the open source of Bitcoin and then create your own new type of virtual currency?). Again, Bitcoin has the first-mover advantage, but who wants to subscribe to using Bitcoins when essentially the scheme has a pyramid scheme style element where the initial players in the market have a huge economic edge on those that start on it today?

My suggestion for those that are genuinely scared of their purchasing power of their money is to invest it in something that will continually be in demand. Whether this is in equities, gold, guns, or fine scotch is another matter – each of the four categories goes through its periods of high and low price variations.