One Good Idea: Buy gold bullion

Gold appreciates amid inflation, defies deflation and is the ultimate defensive play

By Diane Maley
Globe Investor Magazine online, December 09, 2008

The Source: Eric Sprott, founder, CEO and portfolio manager, Sprott Asset Management Inc.

The Idea: Buy gold bullion.

"I can only recommend one thing: precious metals," Mr. Sprott said in an interview. Governments worldwide are printing money furiously in a vain attempt to bail out the banking system and keep the economy afloat, he said. With the purchasing power of currencies being eroded, the only real safe haven is gold, he argues. "The developed world is throwing $20-trillion (U.S.) at the banking system. There are holes in the dike. You had better be ready for the worst of all possibilities."

The allure of gold bullion is that it tends to hold its purchasing power, adjusting for currency shifts, rising with inflation and holding its value even in deflation. In a deflationary environment, even if the nominal price of gold just holds steady, its purchasing power will rise as other prices fall. That's important, because Mr. Sprott says the world is in "a deflationary death spiral."

Given the steepness of the economic slump, companies will be hard pressed to earn a profit and stock prices will languish, Mr. Sprott predicted.

"You've got to try to survive this thing." What about buying precious-metal stocks or gold-backed certificates instead of the metal itself? "With stocks, you need the price to go up," he said. "If you buy bullion, if it just holds its value, you will be okay." Gold bullion could hold steady, yet gold stocks could fall.

"I own lots of gold stocks, don't get me wrong. But to be really defensive, gold is the only place to be." As for certificates, "I tend not to be a big believer in anything that is just a piece of paper in your hand . Our banks sold citizens $35-billion of paper they said was good but it wasn't," he said, referring to asset-backed commercial paper.

The Payoff: The purchasing power of your hard-earned dollars will be undiminished, regardless of what the future holds.

The Big Risk: The price of bullion could drop or prices of other investments could rise, leaving you to reflect that you could have done better investing in something else.

Why listen to Eric Sprott? Until this past summer, Mr. Sprott has had a stellar track record. But plunging commodity prices, especially for oil, dragged down both his hedge funds and the mutual fund he manages, the Sprott Canadian Equity Fund.

Since then, the hedge funds he manages have recovered and are flat to slightly higher for the year. The mutual fund, which cannot sell short, is down 47 per cent in the year to Nov. 28.

In October, a fund Mr. Sprott manages for international investors, the Sprott Offshore Fund Ltd., won an award from HFM Week, an industry publication, for the best long-short hedge fund in the world.

Special to the Globe and Mail