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All That
Glitters?
Adrian Lowcock,
Senior Investment
Adviser at BestInvest,
explores a question
facing many investors
In just over a decade the gold price has rocketed
481 per cent (peak to trough). For some it’s
been a profitable ride but with the gold price
now back around its all-time high, the question
remains; is it still a wise investment?
The answer to this question is more complicated
for gold than other metals because of its perception
as the ultimate store of wealth. This creates an
intangible value which, of course, varies for each
investor. By contrast, the main sources of gold
demand and supply have varied very little. Gold
mine production has increased only slightly year on
year for the past ten and given that new mines take
up to a decade to become operational, and that
discoveries of new deposits are falling, this means
mining alone is unlikely to produce a significant
increase in supply. Until now, scrap gold has been
the main source of new supply although it’s not
expected to increase significantly from now.
Additionally, demand for gold has changed
recently. The most telling change has been in
relation to central banks in the developed world;
these had been transferring gold to emerging
markets, with China, Russia and India all
markedly increasing their gold ownership. But
while the appetite for gold among emerging
market central banks remains undiminished
– they still own far less than the OECD
(Organisation for Economic Co-operation and
Development) average because the OECD banks
no longer wish to sell.
Last year, for example, the IMF (International
Monetary Fund) was the only major global
financial institution to sell some of its reserves and
almost all of the 403.3 metric tonnes were bought
by India and China. This is quite a sea change for
the gold market as central banks are now a source
of demand. This will help support the gold price
and should provide some reassurance to investors
as to the long-term demand picture. The long-term
supply picture is also broadly supportive. This is
because new deposits tend to be in more marginal
areas and, frequently, in politically unstable parts
of the world.
The recent surge in demand for gold exchange
traded funds (ETFs) provides a good indication
of how great an influence more intangible factors
continue to have on the gold price. ETF demand
accounted for 7.3 per cent of global gold supplies
in 2010 and 14.6 per cent in 2009. This is a
considerable new source of demand which has
also helped to drive the gold price. However, this
effect could be reversed.
These dynamics have pushed specialist gold
funds to the top of the performance tables over
the last year and, in the current environment,
it’s difficult to see why the gold price should fall
substantially. Quantitative easing has devalued
all major currencies relative to gold, although
this is likely to end soon. Meanwhile, markets
remain concerned about inflation to which gold is
perceived as a good hedge. More broadly, the gold
price also benefits from geopolitical unrest and
there is no shortage of this on today’s world stage.
Gold can therefore be considered a reasonable
inclusion in a diversified portfolio, even at current
prices, although it would be unwise to extrapolate
gold’s recent outperformance.
Our view
The introduction of gold-based ETF’s has
created a new breed of investor which has helped
drive the price of gold up over the last decade.
However these investors can easily sell should
their view change which would cause a collapse
in the price of gold. As such, investors should be
cautious of using the past performance of gold
as an indicator to the future gains. In the current
conditions we prefer accessing gold through
investing in companies that mine gold as opposed
to the underlying metal itself. The price of gold
mining companies remains cheaper relative to the
current gold price and therefore offers a chance
for better returns. n