Should you invest in gold?

15 June 2009

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 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.

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