Does investing in gold have a future?

Last updated: August 23, 2013 7:33 pm

Does investing in gold have a future?

By Jonathan Eley

Few asset classes polarise opinion quite like gold. For some, it is the ultimate store of value that has withstood every crisis for millennia and will still be standing when the world’s financial system finally collapses under the weight of its own debt. For others, it is the “barbarous relic” that John Maynard Keynes so disdained, a non-productive, non-yielding asset beloved of crackpots and conspiracy theorists.Love it or loathe it, gold has certainly been one of the investment stories of the past decade. When Gordon Brown, as chancellor of the exchequer, announced in May 1999 that a substantial portion of the UK’s gold reserves would be sold, the price stood at about $280 per ounce.

From that point, gold rose to a peak of over $1,900 per ounce in 2011, at which point the SPDR Gold ETF, a US exchange-traded product that tracks the gold price, had more assets under management than the same provider’s S&P500 equity tracker.

The pace of the gains picked up after the collapse of Lehman Brothers in September 2008; having gained just over 120 per cent in the five years up to that point, gold rose by the same amount again in the three years to its peak. In sterling terms, the rally since 2008 has been even more spectacular, thanks to the weaker pound.

However, gold ran out of steam in 2012, and has suffered some sharp reversals in 2013. An initial lurch downward in April was followed by more sustainedselling in June, after Ben Bernanke said that the Federal Reserve’s bond purchases might start to wind down this year. Over the past two weeks, it has been reported that famed hedge fund managers such as George Soros and John Paulson have either reduced or exited their gold positions.

A significant factor in this year’s declines has been the withdrawal of assets from exchange-traded productsbacked by physical gold. When one private investor sells an exchange-traded commodity (ETC) to another, the physical gold that backs it remains in the vault. But when big institutions decide to redeem their holdings, those units are cancelled by the provider and the gold that backs them is sold, explains Townsend Lansing, head of regulatory affairs at ETF Securities. “There were very heavy redemptions between April and June although it has eased up recently,” he notes.

This is a reversal of the situation in the last decade, when the creation of new units resulted in a huge increase in gold demand from ETC providers. In 2009, the peak year for such inflows, net demand reached 623 tonnes. So far in 2013, some 578 tonnes has flowed out. “The redemptions have been roughly equal to the amount of gold that entered vaults in the nine months after Lehmans,” notes Marcus Grubb, managing director of the World Gold Council, a promotional body funded by gold mining companies.

Short selling on the US futures markets, another big factor in gold’s recent declines, has also eased. Data published by the Commodity Futures Trading Commission in the US showed that in the week to August 6, net short positions among “non-commercial users” (speculators) fell by almost 24,000 contracts. “The last time gold shorts unwound at this rate was in 1999 and 2000, when there was a 33 per cent rise in the price over three weeks,” said Jane Sydenham, investment director at wealth manager Rathbones.

Physical gold demand tends to be very price sensitive, so the year’s price tumbles have resulted in a surge of interest in Asia. According to the World Gold Council’s figures, second-quarter jewellery demand worldwide rose by 37 per cent. In both China and India, jewellery demand was up more than 50 per cent, while demand for the small bars and coins typically bought for investment purposes more than doubled in both countries. “The evidence so far is that this demand is pretty resilient,” says Mr Grubb.

However, others say the surge in jewellery and private investment demand needs to be seen in context. “Asian demand is not the price setter. The price of gold is set by the speculators and I can see a challenging period ahead,” says Neil Gregson, manager of JPMorgan’s £1.06bn Natural Resources Fund. It has a benchmark weighting of one-third to gold miners, but is currently about 15 per cent invested in the sector. “There are a lot of headwinds, such as the end of quantitative easing and a more stable dollar, which is now the least ugly of the major currencies.”

Mr Gregson is more upbeat about prospects for miners of key industrial metals and ores, especially copper, iron ore and uranium.

As gold produces no profits and pays no dividends, it’s hard to value in the same way as shares, bonds or property. Those who follow price charts say gold seems to have found some support at around $1,200 per ounce. “We may have reached a bit of a bottom. It’s hard to see gold much below $1,200 at the moment. On the other hand, yields are rising, which should be negative for gold,” said Kathleen Brooks, research director at Forex.com, who thinks it most likely the metal will trade in a $1,250-$1,350 range for the remainder of the year.

There is less ambiguity about the value of gold mining shares, which were lagging behind the bullion price even before this year’s volatility. A global index of gold miners compiled by Datastream, a data provider, shows they have fallen by 58.9 per cent since September 2011, compared to 27.5 per cent for bullion in dollar terms. In the first half of the year, specialist gold mining funds were among the worst performers.

David Butler, head of metals and mining at Barclays, said even after recent falls, many gold miners’ shares did not look particularly attractive in valuation terms. “A key thing is that most of them didn’t harvest any benefit in the halcyon days of the gold price because they allowed their cost bases to blow up,” he says. “The only two in the UK space that have been reasonably resilient in operational terms areRandgold and Fresnillo.”

The debate about whether it’s best to gain exposure to gold via bullion or via shares in gold miners is a secondary one, though. The main question is what role – if any – gold should play in the portfolio of the ordinary investor. Opinion is fairly evenly divided. Those convinced that the financial crisis has yet to fully play out view it as an insurance policy against further turbulence in financial markets and the debasement of paper money. “Gold to us is money that cannot be printed,” wrote Sebastian Lyon to investors in the Troy Trojan fund in May. “Holding gold is something we believe we need to do.”

Others cite its credentials as a hedge against resurgent inflation, although gold’s inflation-fighting criteria may not be all they seem.

An analysis of returns in 2012 by Elroy Dimson, Paul Marsh and Mike Staunton of London Business School suggested that gold often fails to protect against inflation – it lost three quarters of its real value between 1980 and 2001, for instance. “Gold has a potential role in the portfolio of a risk-averse investor concerned about inflation,” the trio concluded. “However, it does not provide an income flow and has generated low real returns over the long term.”

The lack of income is a key reason that many sceptics cite for not owning gold. A dependence on price movements means it is essentially speculative, rather than an investment, they argue.

——————————————-

Twitter debate: Should private investors own gold?

YES

It’s worth having some exposure to gold as a hedge against future inflation. The impact of quantitative easing has been underestimated. Adrian Lowcock, Hargreaves Lansdown

Yes. Insurance! Buy and hold against disaster. Don’t trade it – think about when it will save your bacon. Chris Gilchrist, FiveWays Financial Planning

They should. But it’s not an investment, rather “a conscious decision to refrain from investing” until sound money returns. Tim Price, PFP Wealth Management

Gold makes wonderful jewellery, and is very portable, and so everyone should
own some. Charles MacKinnon, Thurleigh Investment Managers

Gold can still offer some protection against an uptick in inflation, and weakening in currencies, so investors can still justify a small allocation in balanced portfolios.
Jane Sydenham, Rathbones

NO

There is no valuation support, no dividend yield and no management to question when it underperforms. And until recently, sentiment has been too bullish. Ross Ciesla, Veritas Asset Management

If you believe that the major disinflationary threats have receded, and that we are entering a prolonged period of weak growth, gold should be far less attractive.Edward Smith, Canaccord Wealth Management

People tend to be driven to gold by fear: fear of inflation and fear that other investments won’t do so well. In my book, fear is not a good motive for investing.
David Meckie, Insight Financial Consulting

Gold is highly volatile. In periods of risk aversion, gold is touted as a safe haven, yet it is anything but. Brian Dennehy, FundExpert.co.uk

MAYBE

As a hedge against tail risk or to protect against debasement of paper currencies, gold may make sense over the long-term. Trading gold presents challenges given that it is driven more by sentiment. Gautam Chadda, RBC Wealth Management

There are three ways to reduce the debt burden: grow out of it, inflate it away or reduce it through debt restructuring. Two of these – inflation and debt restructuring – are potentially positive for gold prices. Ashish Misra, Lloyds Private Banking

Gold is prone to speculation. Essentially it is worth what the next person will pay you for it. Jason Hollands, Bestinvest

——————————————-

Gold shares and funds

Pros: 
● Leverage to gold price
● Can pay dividends
● Have fallen more than bullion
Cons: 
● Correlated to stocks, not gold
● Geological and political risks

Exchange traded commodities

Trade like shares but give exposure to a specific commodity

Pros:
● Easy and cheap to trade
● No storage or insurance worry
● Most backed by physical gold

Cons:
● Element of counterparty risk
● Imperfect tracking due to costs
● Not all can be put in Isas

Spread bets

Enables investors to bet on the direction of the price of gold
Pros: 
● No foreignexchange risk
● No tax on profits
● Leverage amplifies gains

Cons: 
● Unlimited downside
● No physical ownership

Small bars and coins

Pros:
● Direct play on gold price
● No value added tax
● Some exempt from capital
gains tax
Cons:
● Bid-offer spreads can be wide
● Potential storage and insurance
costs

Fractional ownership

Allows individual investors to own a share of gold
Pros:
● “Good delivery” bars
● Secure storage and insurance
● Direct play on gold price
Cons:
● Fees for holding
● You don’t get to keep gold
● Currency risk

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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