Should you invest in gold?
A gold rush starts when someone spots something glinting on the riverbed. Soon men in 10-gallon hats arrive and start sifting pebbles. Some of them strike it rich and, before long, the area is swarming with increasingly desperate speculators. But, by then, you’re more likely to lose your shirt than make a fortune.
We’re in the middle of a gold rush right now, albeit a rush to invest in gold rather than extract it. In 2008, according to the World Gold Council, the demand for gold from private investors rose 396%, from 61.4 tonnes in the last quarter of 2007 to 304.2 tonnes in the last quarter of 2008.
So where are we in the lifecycle of this gold rush? Can gold still be a rewarding investment, or do we risk joining the influx of desperate speculators?
The price of gold has certainly performed well. From 2007 to 2009, the dollar price of gold rose from around $600 to $1,000. It has been volatile since and struggled to reach those heights again, but it beat all other asset classes in 2008.
But it’s by no means a one-way bet. There have been periods where strong rallies have been followed by alarming falls. The end of the 1970s, for example, saw a spectacular gold bubble, as concerns over oil prices, Soviet intervention in Afghanistan and the impact of the Iranian revolution led to a rush on the metal.
Chris Wyllie, partner and head of portfolio management at the Iveagh Wealth fund, says: “This was a classic bubble. It went from $200 in January 1978 to $700 two years later. It moved very sharply up, then bang.” The price fell to just over $300 two years later and has taken almost 20 years to climb back to those highs.
So the first question is: what’s going to happen next? To understand whether gold is destined to rise further, we need to know what is going to happen to supply and demand. Gold is limited in supply, and production has been in decline since 2003.
Moreover, it’s more expensive to extract the metal in today’s main mining areas: China, Central Asia and Latin America. The financial crisis has also meant some mining companies have had to shelve plans for new mines.
Demand, meanwhile, depends on four things: general economic wellbeing; currency markets; the outlook for inflation; and sentiment.
First, gold does well in times of economic uncertainty. Nicholas Brooks, head of research and investment strategy at fund provider ETF Securities, says: “When investors are unsure of the global political, economic and financial climate, gold is where they go.”
Mark Dampier, head of investment research at Hargreaves Lansdown, says this is what has been happening recently: “When equities are considered too risky, people move to corporate bonds, then to gilts, then to US treasuries. When those are too risky, the only place left is gold.”
With this in mind, the main question is: what’s going to happen next to the economy? The problem is that no-one knows. The International Monetary Fund has predicted dire times ahead until at least 2011 – which would be good for gold. However, the equity rally at the end of March could throw a spanner in the works if it detaches from the real economy and starts a recovery. Wyllie says: “I wouldn’t be surprised if the gold price weakened a bit if equities rally.”
Secondly, when people are worried about what’s happening to currencies, they turn to gold as a safe alternative. Currencies are certainly under fire now. Brooks says: “Central banks, including the Bank of England, the US Federal Reserve, the Swiss National Bank and the Bank of Japan, are all printing money. If just one currency was printing money, it would depreciate against the others. But because they’re all doing it, they are depreciating against gold.”
Thirdly, in times of worries over inflation, gold does well because it holds its value and can protect you from the erosion of the value of your assets. But the opposite is true in times of deflation.
The fourth issue is sentiment. Wyllie warns: “People have spotted the opportunities in gold and it’s becoming a rather crowded trade.” So part of the reason for the high price could be over-reaction, and this could unwind if sentiment changes, leading to a price fall.
The answer to all the uncertainty may be to only take a small holding. Andrew Wilson, head of investment at wealth advisory firm Towry Law, says: “We always buy some gold as part of a multi-asset portfolio, as a long-term holding rather than for trade. But we only have a few per cent in it.”
If you decide to invest, there are a number of routes you can take.
You can physically buy gold. Jewellery is one option but the price includes the craftsmanship as well as the metal, plus VAT. You can buy coins and small bars through specialist shops: the World Gold Council website lists UK outlets. But you pay a premium of up to 20% over the live price of gold, and have the worry of storing and insuring it.
Recently, new investment routes have opened up, such as bullionvault.com. This pools investors’ money to buy collectively owned ingots held in professionally managed vaults. Around £2,000 is a sensible minimum investment.
Exchange-traded commodities are the most easily traded option for small investors. Like exchange-traded funds, these are designed to track a sector, in this case gold, and mirror the performance of the index.
Brooks says this gets round the hassle of owning physical gold: “Investors just go to the stock exchange and buy the right to a piece of gold. You can trade in and out at any stage.”
However, Wyllie advises: “Make sure it’s backed with physical gold rather than a derivatives contract. It’s best to get as close as possible to the real thing.”
The third option is to buy shares in gold mining companies through a fund investing in a selection of them. The most widely recommended is BlackRock Merrill Lynch Gold & General. But Wilson warns this isn’t a straightforward decision. “Gold miners have done worse than gold in the last 18 months,” he explains.
“This could be because they’ve suffered from the general movement of stocks, which would mean this is a good opportunity to buy in. But it could also be that you no longer have to buy miners to buy gold as you can buy ETCs instead, so mining stocks are being de-rated.”
Whichever route you choose, you’ll face a certain amount of volatility. Haynes says: “Although gold is seen as a safe haven, it can be very volatile in the short term. The experts say that over 10 years it’s less volatile than equities, but it’s much more volatile than cash.”
It’s important not to hang onto gold if it’s dropping like a stone because it doesn’t produce dividends or interest payments like bonds or shares, so it won’t make money as you go along.
Wyllie says: “You have to sell it at a profit to make anything.” Many investors prefer to get exposure through multi-asset or absolute return funds, with the flexibility to invest in gold where there’s an opportunity and move out of it when it represents poor value.
Taking a small-scale, measured approach may not seem like the best way to profit from a gold rush, but Dampier says: “Around 12 months from now, some people will have beaten the market because they took a speculative position in gold and it turned out to be right. But remember, they will have taken some very high-risk bets to get there, and run the risk of some spectacularly poor numbers.”
What about other gems and metals?
Silver, platinum and diamonds are useful alternative assets, but are very different from gold.
Chris Wyllie, head of portfolio management at the Iveagh Wealth fund, explains: “Gold is not really consumed, whereas the others are industrial materials as well. This can be a good thing because over-supply is removed through consumption. But you’re exposed to the industrial cycle and there are concerns about that at the moment.”
Platinum, for example, is used in catalytic converters, so the dramatic fall in demand for new cars means demand for the metal has fallen.
Andrew Wilson, head of investment at Towry Law, says platinum and silver prices are a lot lower than gold at the moment, so there may be an opportunity in the market. He says: “You could hold it as a complement to gold; it tends to do well when the dollar’s weak.”
But these are niche investments and should be held as a very small part of any portfolio.
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).
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
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.
This is the opposite of inflation and refers to a decrease in the price of goods, services and raw materials. Economically, deflation is bad news: the only major period of deflation happened in the 1920s and 1930s in the Great Depression. Not to be confused with disinflation, which is a slowing down in the rate of price increases. When governments raise interest rates to reduce inflation this is often (wrongly) described as deflationary but is really an attempt to introduce an element of disinflation.
Absolute return funds
Absolute return funds aim to deliver a positive (or ‘absolute’) return every year regardless of what happens in the stockmarket. Unlike traditional funds, they can take bets on shares falling, as well as rising. This is not to say they can’t fall in value; they do. However, over the years, they should have less volatile performance than traditional funds.
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.