Gold futures are about leverage

Oct 4th, 2010 – Comment

Yes you can borrow to buy stocks and ETF’s but not at the same ratio as a commodity futures contract


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Lou Schizas is an equities analyst, investor, entrepreneur, professor and television and radio personality – and a true believer in the happiness-inspiring powers of capitalism.


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Hi Lou,

Can you please help me understand why gold has steadily marched up to ring the $1,300 bell and yet the share price of most gold companies has just been sitting quietly on the sideline?

Did someone not invite them to the party?

In fact, for the past few weeks the shares of IAMGOLD Corp., for example, have been moving in the opposite direction of the price of gold.

Your Brethren in Capitalism!!

Thanks,

Steve

Hi Steve,

Great question. It seems counter intuitive but there are different reasons for buying gold as bullion and buying the stocks of gold mining companies. When we examine the different motivations we can see why one investment advances further and faster and another seems to be a laggard.

The three year chart for gold is suitable for framing as a classic example of a sustained uptrend. What you need to know about the price of the commodity is that it is a leveraged asset. You can buy a contract for 100 ounces of  gold with only a fraction of the price of the asset required as a premium. With that kind of leverage you tend to get lots of hot money chasing the opportunity. Keep in mind that only forty percent of all contracts are tendered to organizations who will actually use gold to fabricate jewelry or apply it to some industrial application. The other 60% of contracts represents purely financial interests. Financial interests is code for speculators.

The three year chart for the Market Vectors Gold Miners ETF(GDX NYSE), which is a good proxy for the sector, indicates that the shares of the miners have gone up but not as aggressively as the commodity. Which brings us to the most difficult single factor in asset management, investor expectations. Often times expectations are beyond what can be reasonably achieved by an asset class. If you can better manage your expectations you should be able to better manage your assets. Let’s face it a Nissan Sentra isn’t going to out race a Ferrari anytime soon but it will get you up the road at a reasonable cost.

The reason is once again leverage. Yes you can borrow to buy stocks and ETF’s but not at the same ratio as a commodity futures contract. The other factor to consider when buying a mining stock is that you have more associated risk when it comes to finding new deposits and bringing them to market whereas with gold bullion what you see is what you get.

I have covered IAMGOLD several times recently you can access the reports in the archives.

Happy Capitalism!

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