From Fraser when we were discussing Mining Stocks. I thought it was excellent analysis and as a far better trader than I - I thought id share his views
What the market missed about the latter end of 2011, was the degree of leverage over Gold & Silver physical derivatives and other exchange traded products. When looking at the price of a product, the 'only' true price is one that meets demand with "true" speculation built in (meaning unleveraged). Gold has for a long time had a declining leverage, for which most people/funds have ignored for whatever their reasons. The final elements leveraged to buy gold are closing quicker than planned, thus the drop…this also presents an opportunity to long as these positions close, albeit catching a falling knife.
When leverage starts to decline and margins need to be increased, or funds are margined out or put under-stress generally the speculators a) cut their losses and close positions b) close positions to protect profits or c) increase their margins. The latter is a point of denial, for which the likes of Paulson are now suffering. Having chosen to ignore all the indicators that he suggested were evident within the financial system, it's now showing he doesn't understand the indicators of "gold stabilisation" and a real price being determined for precious metals.
Not only does the Gold drop have an impact on speculators, it also promotes people to 'run' to safer stocks that infer dividends. Gold, it has been assumed will show vast returns and people have naively invested in gold companies assuming those returns will come in the form of profits. When in reality there is a stark differential between Gold and a Gold Miner, 90%+ of all the risk is with the Miner with little of the upside.
Why people have opted and become fixated with Gold Mining Companies is anyone's guess, perhaps a misguided belief that if gold is going up, then Gold Miners should. History has rarely shown this to be the case, with monies leveraged during "commodity" gold rushes. The danger is for those leveraged and with higher cash costs that they are unable to see any form of financial return.
Very little work is put into companies analysis of 'true capital and cash costs' where they find themselves in a bear/falling market having bet on a leverage asset that will struggle in the depreciating environment.
Paulson believes gold is an inflation protector, this is at the very least naive and best a weak justification for large exposure. The only elements that truly protect against inflation are items grown for food or industry. So people should have been purchasing land rather than gold as this is the base model.
When people realise the difference between a Miner and a Commodity, they'll perhaps essentially admit why they should not have been in the Miners since late 2010. Hindsight is a wonderful thing, but generally the 'signposts' for those not in denial is clear very early on. All the signposts were there…leverage reducing, costings increasing, supply increasing and demand reducing…Including other items such as “more cash required for day-to-day living” thus less to invest in the likes of gold. Remember investments are based on a hierarchy of needs, as Maslow suggested, but with a few twists!
I fail to see why people are investing in companies with such poor Investment Rate of Returns. There are good companies out there with 25%+ IRR but not often commented on and avoided by speculations betting on high risk (but without the ability to assess what is high risk). Petropavlovsk (LSE:POG) being a prime example. Investors or Funds don’t understand the model, because most are only moderately qualified to do so. This is why I prefer more historic results and higher returns towards the 80+ percentile per annum including investment in International Arbitration Claims.
Likewise, people need to look at essential products and minerals, such as Iodine and Lithium etc...where demand is outstripping supply significantly.