John Hathaway's 10 rules to keep in mind before investing in gold

John Hathaway is a famous portfolio manager who joined Sprott Asset Management in January 2020. Hathaway is a Portfolio Manager of Sprott Hathaway Special Situations Strategy and Co-Portfolio Manager of the Sprott Gold Equity Fund.

Hathaway earned a B.A. from Harvard College and an MBA from the University of Virginia and also holds CFA designation. Hathaway began his career in 1970 as an equity analyst with Spencer Trask & Co.

Previously, Hathaway joined Tocqueville Asset Management L.P. in 1997 where he was a Co-Portfolio Manager of the Tocqueville Gold Fund.

In the interview, Hathaway offered ten nuggets of practical wisdom for those contemplating gold ownership. Let's look at these points-

Hathaway says if investors expect or fear rising inflation, destabilizing deflation, a bear market in stocks or bonds, or financial turmoil, they should consider investing in gold. Understanding the internal dynamics of the gold market can be helpful in investment timing issues.

Hathaway says the weekly position reports of commodity trading funds or sentiment indicators offer useful clues as to entry or exit points for active trading strategies but none of these reports yields any insight as to the broad market trend.

"The same can be said for reports of central bank selling and lending activity. Central banks are bureaucratic institutions and in their judgements, they are essentially market trend followers," he says.

Hathaway says returns from a “buy and hold” strategy should be more than sufficient to compensate for the inherent gold volatility.

"Many who have tried to outsmart this market by hyperactive trading have underperformed. Success is dependent in large part on the occurrence of “fat tail” events that lie outside the parameters of trading models," he says.

Hathaway says investors should have a reasonable allocation in a conservative, diversified portfolio of around 0-3% during a gold bear market and 5%-10% during a bull market.

Hathaway says gold equities tend to appear expensive in comparison to those of conventional companies because they contain an embedded option component for a possible rise in the gold price.

"The share price sensitivity to a hypothetical rise in metal price is related to the cash flow from current production as well as the valuation impact on proven and probable reserves," he says.

Hathaway says investors should review financial statements of companies and give special attention to hedging arrangements as it could undermine participation in higher gold prices or even jeopardize financial stability.

"Individual stock selection is less important than identification of the primary trend," he says.

Hathaway says even though gold itself is a conservative investment, “gold fever” attracts a crowd of speculators and promoters who only want to separate investors from their money.

"Avoid offbeat “exploration” companies with little or no current production and gargantuan appetites for new money," he says.

Hathaway says gold provides greater liquidity for large pools of capital and investing in the physical metal requires scrutinizing the custodial arrangements and the creditworthiness of the financial institution.

"Do not mistake the promise of a financial institution to settle based on the gold price, for example, a “gold certificate” or a “structured note”, (i.e. derivative), for the actual physical possession of the metal. Insist on possession in a segregated vault, subject to unscheduled audits, and inaccessible to the trading arrangements or financial interest of the financial institution," he says.

Hathaway says investors should not rely on conventional financial media and brokerage house commentary for taking cues for investing in gold.

"In this area, such commentary is even more misleading and ill-informed than usual," he says.

Hathaway says gold represents insurance against some sort of financial catastrophe and the magnitude of the upside is a function of the amount of paper assets that would be converted to gold irrespective of price so investors should strive for maximum profit in gold.

(Disclaimer: This article is based on John Hathaway's interview to a financial website)