The Psychology of Gold and Gold Stock Investing: Of Irresistible Forces and Immovable Objects

12 April 2008

This entry must be brief, but it represents the culmination of much thinking.

Since the gold bull market began, gold stocks - meaning producing gold miners of all sizes, emerging gold miners, and gold explorers with approved feasibility studies - have always sooner or later caught up with and then exceeded the advances of gold. That is, until February 2006.

Since February 2006, this familiar pattern has failed to reassert itself.

While there has been much discussion of the rising costs of gold mining, I think the greater factor right now is paradoxically the same one that is driving the price of gold ever higher - illiquidity in the investment markets.

Quite simply, gold mining - from exploration to proving up resources to getting the material out of the ground (in an environmentally-acceptable manner) to refining and selling the product - is an incredibly complex, uncertain, and capital intensive process.

That is, operating a gold mine is exactly opposite to owning gold.

There is no investment simpler than owning gold. There are no interest payments, no coupons, no stock certificates, no annual reports, no government regulations or investigations. The value is in the possession of the physical metal itself. The primary complicating factor is storing it safely, but that is far less complex than developing and operating a gold mine. And you can now arrange for others (for example, Streettracks Gold Trust, Kitco, the Bullion Vault, and many more) to hold your gold for you.

And that, in short, is today's problem.

The drying up of liquidity in the financial markets means that for now, there are fewer funds available for investment in new projects of any kind, let alone a project as complex or unpredictable as developing a gold mine.

Think further, though. This same phenomenon that is presently discouraging the construction of new mines (apart from those being developed by already cash-rich larger mining companies) is contributing further to the relative scarcity of gold, driving its price higher still.

So too, illiquidity in the financial markets makes gold more attractive, because gold is always exchangeable for other items of value when the need for such exchange arises. Add to that the influence of financial uncertainty and money supply inflation around the globe (you can print all the money you like - just ask Robert Mugabe - but you can't create more gold at will), and you have the recipe for a continued surge in the now 7-year-old gold bull market of the present millennium .

Therefore, the irresistible force referred to in my title is certainly the ever-rising price of gold.

While many are now calling a top in the current gold price, I'm not so sure we are there yet. In today's crisis environment, the fundamentals are stronger for gold than we have seen since the 1970s stagflation era. Gold may still prove to have more room to rise.

The immovable object referred to in my title is illiquidity in the financial markets.

Basically, when investment funds are flowing freely, particularly in an inflationary environment as now exists, speculative ventures - such as mineral exploration and mine development - can be funded because that kind of "overflow" of funds characterizes speculative markets.

The same bubbling markets that could fund the development of so-called "financial innovations" in the mortgage sector also produced overflowing funds which poured into mineral exploration and development stocks - until about February-April 2006. Then the flow of funds gradually dried up.

Since February 2006, market liquidity has been evaporating, and this environmental shift has hurt the gold miners and explorers - particularly the smaller players who rely upon external sources to fund their ventures.

In short, the speculative money has now dried up, and the mineral explorers and developers are feeling it - big time - right along with the mortgage lenders and the indebted consumers!

Here then, is the ultimate paradox - the fundamental contradiction. Gold miners and explorers are holders of gold, just as are gold investors and most global central banks. It is just that their gold is in the ground, waiting to be recovered - through processes that will be lengthy, complex, uncertain and costly.

As current fundamental market conditions continue to boost the price of gold - in my view, probably more than currently expected by most investors - at some point, investment in exploration and mining projects will appear less risky than investing in mainstream assets in uncertain times.

Owning shares in gold miners and explorers will once again be perceived as another way to be a holder of gold - an investment position that will be ever more greatly esteemed as the value of gold continues appreciating, and particularly if competing asset classes plateau or clearly begin to decline in value.

So, my prediction is that today's paradoxical psychology in the gold mining and exploration sector is set to shift at some unknowable future point in time.

When this psychological shift occurs, don't be caught off guard. And don't be surprised to see a dramatic turnabout in investor psychology.

In the investment world, over many centuries, there have been few investment vehicles of more mythic proportions than gold and silver mines.

The time will come again, when the irresistible force (accelerating gold prices) meets the immovable object (market illiquidity), and one force or the other must yield while the other predominates.

When this happens, my call is that it is the irresistible force which will prevail.

The market value of gold mining and exploration shares will surge again, very likely when least expected.

The scale of the phenomenon may prove astonishing when it finally occurs. There is much activity beneath the surface, and it should prove very powerful when manifested in the marketplace!

I wish I knew when. However, my guess is - it will be soon enough....