How you can profit from gold and oil
Against a global backdrop of high inflation, economic turmoil and political instability, investors are turning to gold and oil as a way to profit from uncertainty.
The BlackRock Gold & General fund, which has plenty of exposure to the precious metal, has been the most popular investment choice among TD Waterhouse's ISA and Self-Invested Personal Pension (SIPP) customers for the past two years and, on the spread betting and CFDs side, IG Index reported a threefold increase in oil trades in March on the back of events in Libya.
There are a number of reasons for this increase in interest, with both commodities offering plenty of benefits to investors in uncertain times.
Mike McCudden, head of retail derivatives at Interactive Investor, says: "When there's any sort of market calamity you often see an uptick in gold as it's regarded as a safe haven. This makes it an ideal tool for hedging against these events."
This is because, although there are always new attempts to mine gold, there is only a finite amount and it's impossible to manufacturer it artificially. However, demand keeps rising. For instance, India is the world's biggest buyer of gold, with events such as the Indian wedding season, which runs from September to December, fuelling demand and often causing a spike in the price.
Gold is also a powerful hedge against inflation.
"It has a negative correlation with real interest rates," says Peter Day, partner at Killik & Co. "As inflation rises and real interest rates fall, the gold price tends to rise as it attracts investors unable to get a decent return from interest-bearing investments."
It can also act as a hedge against currency debasement. When governments use steps such as quantitative easing to revive their exports and reduce the pain of heavy levels of debt, this devalues the currency. But this can't happen to gold, so providing demand remains the same, its price will increase. Day adds: "Printing money creates inflation, which also helps the gold price to rise."
Given all these conditions that help to push the price up, it's not surprising that returns have been impressive.
Michael Hewson, market analyst at CMC Markets, says that since 2000, when the price bottomed out at $250 per ounce, gold has increased in value by around 700%. "John Maynard Keynes described gold as a 'barbarous relic', but I wouldn't call that performance barbarous."
And the good news for gold investors is many believe the conditions that stimulate demand are set to continue. Day says that while governments in the West are looking to stimulate economic recovery, interest rates will remain low with inflation a natural side product.
The arguments for investing in oil are slightly different, but it is also regarded as a relatively safe bet when the stockmarket isn't performing so strongly. "People need to use oil whatever the economy is doing," says James Daly, investor centre representative at TD Waterhouse.
These dynamics are strengthened by constraints over supply resulting from the political unrest in North Africa and the Middle East. And, while the Japanese tsunami has reduced demand for oil in that country, the growth of emerging markets continues to make oil an attractive investment. Indeed, according to Longview Economics, China's share of world oil consumption is set to increase from 9% in 2008 to 20% in 2020.
Gaining exposure to gold and oil
Given the demand for both gold and oil, many advisers recommend holding some in your portfolio and there are a number of ways to achieve this.
With gold, it is possible to hold it directly, for instance as coins, such as krugerrands and sovereigns, or as gold bars. But there are disadvantages. Unless you want to keep your investment at home, in which case insurance will need consideration, you will be charged storage. For example, bullion house Gold Investments charges an annual fee of £2 per ounce to hold gold in its vaults.
Exposure to both commodities can be gained through shares, albeit in slightly different ways. For oil, it's possible to invest directly in companies producing oil - such as Shell, BP, Tullow Oil and Premier Oil.
With both commodities, you can also get exposure by investing in gold mining companies and the oil exploration and production sector.
"This is highly speculative but it can also be regarded as a highly geared way of playing the commodity price," says Day. "If the company finds a good source of gold or oil, its profits will increase, while its fixed costs remain the same."
It's not the easiest market to tap into though.
Daly says the investors he sees going into these companies tend to come from that background. "The companies tend to be very small, which can make it difficult to research which ones are likely to perform well. It can be quite intimidating," he explains.
For anyone looking to speculate on short-term moves, the way gold and oil prices move also make them ideal candidates for spread betting and CFDs. "Gold and oil appeal because of the volatility in the price," explains David Jones, chief market strategist at IG Index. "The price can also move a lot in a short period."
As an example, Jones says that as a result of all the turmoil in the Middle East and North Africa, the oil price moved from $96 to $106 dollars in a few days, with a movement of $6.50 happening in just one day. "That's 650 points, which can be scary if it moves against you," he adds.
As well as being able to go short as well as long on both gold and oil, you could also consider taking a position on companies that are heavily influenced by the fortunes of these commodities. While this is less of an option with gold due to its luxury status, the price of oil is a significant factor for many companies and industries.
McCudden explains: "Many industries are dependent on oil, for instance the airlines and other travel firms and haulage companies. If there's a spike in the oil price, the increasing cost to run the business will affect the share price, usually causing it to fall."
Another suitable option for gaining exposure to gold and oil is an exchange traded fund (ETF) or exchange traded commodity (ETC). These track the price of gold or oil, either by holding the commodity directly or by using derivatives to replicate it, and are bought and sold like shares.
"There's plenty of choice, including ones that go short rather than long and ones that leverage your investment," says Daly. "Although there are exceptions, ETFs do tend to be regarded as a more long-term investment than spread betting and CFDs."
Charges are a consideration. Although ETFs and ETCs are not subject to stamp duty, there are dealing charges when you buy and sell, and an annual charge is included in the pricing.
Dos and don'ts of gold and oil
* Do consider gold as a hedge against inflation, currency debasement and stock market falls.
* Do consider a spread bet or CFD for short-term speculation on gold and oil as these allow you to go short as well as long.
* Do weigh up the potential losses on a spread bet or CFD if the price moves against you.
* Don't expect a smooth ride. Prices of these two commodities are very volatile and can jump quickly.
* Don't overlook the influence of oil on other companies in your portfolio.
* As well as the obvious candidates such as BP and Shell, the oil price will affect the performance of companies such as airlines, haulage firms and transport companies.
* Don't forget ETFs. These offer the option to go long or short on gold and oil and their low costs make them more suitable than spread bets and CFDs as a long-term investment.
This article features in the May 2011 issue of Money Observer
Allows you to bet, or take a position, on whatever you think a financial market will do next. The more the market moves in your favour (up or down), the more you profit, with unlimited potential. Similarly with losses, if the market moves against you. A spread betting company will offer a quoted “spread” on an index, share or even elements of a sporting fixture. If you think a market is set to rise, you ‘buy’ at the top end of the quote (the offer price), or if you think the market will fall you ‘sell’ at the bottom of the quote (the bid price). All gains are tax-free but you will have to deposit money with the spread betting company to cover any losses and if your losses exceed that, the company will demand more money to cover your loss-making position. Spread betting is risky; it’s for people who know what they’re doing rather than for novices.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An Exchange traded fund is a security that tracks an index or commodity but is traded in the same way as a share on an exchange. ETFs allow investors the convenience of purchasing a broad basket of securities in a single transaction, essentially offering the convenience of a stock with the diversification offered by a pooled fund, such as a unit trust. Investors buying an ETF are basically investing in the performance of an underlying bundle of securities, usually those representing a particular index or sector. They have no front or back-end fees but, because they trade as shares, each ETF purchase will be charged a brokerage commission.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
A complicated financial instrument, Contracts for difference are a specific type of derivative. They were developed to allow the capital benefits of investing in an asset without actually physically having to own or pay full price for it. A CFD is a contract between a buyer and seller, stipulating the buyer will pay to the seller the difference between the current value of an asset (share, bond, commodity, index) and its value at contract time. If the difference is negative, then the seller pays the buyer).