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SPDR Gold Trust (ETF) (GLD), Barrick Gold Corporation (USA) (ABX): Should You Trust Gold?

Unemployment is still a major issue. The Fed has pointed at the unemployment rate as a key number that influences their policies. Like a plague, unemployment has spread north to Canada, and Europe continues to lag.

Currencies are seeing a race to the bottom, with every bank trying to finesse their currencies into a price that is more acceptable to them. Japan, in an effort to avoid yet another lost decade, has announced more easing. The effect on the Yen was substantial, but it remains to be seen if the change has any staying power.

The EU and other European countries are likely to have loose monetary policies while the situation remains dire. Some other countries, such as Australia, have hinted that a looser monetary policy might be in the works. All the easing has had the affect of pushing up some other countries’ currency.

In the case of the U.S., the currency has gotten stronger against some others despite all the easing. That is likely to trigger another round of easing. A country with as much debt as the U.S. cannot have a currency that is too strong.

Gold ETFs for metal exposure with an option income attachment

It seems to be the a perfect storm for gold, for which I use SPDR Gold Trust (ETF) (NYSEARCA:GLD) as a poor representative. I question gold’s status as a safe haven. It proved true in the years following the financial collapse, but in the last decade, nothing suggests gold’s status as a safe haven.

Gold had a positive correlation with the stock market in the 2000s even if it was weak, if it also has a negative correlation during times of fear, gold should never decline considering the uncertainty and persistent worry of the last five years. Gold is an investment like any other. It is subject to the same forces, and that means that other factors besides fear and inflation can drive the price of gold.

I initially thought a 10% gain was possible before the about face, I now realize that I was wrong. SPDR Gold Trust (ETF) (NYSEARCA:GLD) is at $132, which is a new 52-week low. There are some problems, with SPDR Gold being an ETF with an expense ratio and holding only the metal, which is exacerbated by a decline in my opinion. It has to sell gold to pay its expenses, which leads to a divergence in the price of the ETF from the spot price of gold. Expenses stay relatively fixed, so the further gold falls the more gold has to be sold.

There is a new gold ETF, Credit Suisse Gold Shrs Cov Call Exc ETN, that both owns shares of SPDR Gold and sells calls on the gold to generate an income. The ETF owns shares of physical gold through shares in SPDR Gold Trust (ETF) (NYSEARCA:GLD), while generating an income through writing covered calls. It means that expenses come out of that income, though shares will be sold if that income falls short. The downside is that covered calls will cut the upside on gold if it moves very fast in a short period of time.

The strike price is around 3% out, and the calls are repurchased before expiry to ensure they do not get assigned, with shares being sold to cover the cost of buying back the calls if necessary. It is a brand new ETF, and the first of its kind for gold that I have seen. You should consider looking at whether Credit Suisse Gold is right for you. A quick reverse on gold’s decline might actually hurt the covered call ETF, because it sells calls only 3% out from the current price.

Mining companies’ margins vaporized

Barrick Gold Corporation (USA) (NYSE:ABX) was originally up for consideration here, since miners might do better than the metal. After some research, I found that miners might actually be worse, since gold in the ground is getting harder to come by. The company is not even on great footing to absorb this decline in gold. Barrick took a huge impairment charge related to its copper business at the end of 2012, which has driven its EPS ttm into the red.

I thought Barrick Gold Corporation (USA) (NYSE:ABX) might see a nice bump before the inevitable decline. It is unbelievable that after months of hating on gold, I think there will be a small rise before it is sent to the underworld, and it skips the rise. Barrick’s situation is more dire than the metal’s itself. Its cost is supposed to around $800-$900 per ounce “all-in,” but in reality, it probably costs more, and at current prices margins could be paper thin.

Gold companies have to put in an increasing amount of money to develop projects. Free cash flow at Barrick Gold Corporation (USA) (NYSE:ABX)has been low, and the ability of the company to actually generate more cash is questionable.

You might consider Vale SA (ADR) (NYSE:VALE), which is a giant miner out of Brazil and has a lot of exposure to industrial metals. It does produce gold as a byproduct of other activities. Flipping the general wisdom that you always want gold “in them hills” might actually be best, considering the increased cost of extracting gold.

Rather than chasing ounces of gold, produce a mass of industrial metals, and take whatever gold comes out with it. Barrick Gold Corporation (USA) (NYSE:ABX) needs to show a stream of gold ounces being produced, but if gold production at Vale falls, it would not matter as long as its copper, iron, manganese, etc. production continues to grow. Vale SA (ADR) (NYSE:VALE) is considered a turnaround stock, but I think industrial metals will go up with time as demand increases with the economy. The same cannot be said of gold.

Conclusion

Gold miners are facing major obstacles. Vale SA (ADR) (NYSE:VALE) offers a lot of diversity and a light exposure to gold. I was wrong about a small rise in gold before the slide. It might be instinct to consider gold oversold and buy it. However, consider the fact that gold has no real intrinsic value. There is no overvalued or undervalued measure that actually makes sense.

In this context, oversold is a psychological condition that has people buying, because so many others have been selling. If nobody buys that as an investment thesis, then gold will languish at its new price range once it arrives there. I have written a lot about not trusting gold, and the one time I kind of did I was proven wrong, so I would avoid it like the plague.

Nihar Patel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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