A golden opportunity or a fool's investment?

WHILE stock markets tumble, investors have rushed to buy gold as a safe haven for their wealth.

LOOKING back, if there has been a marked investment to be in since the financial crisis began in 2008, it has been gold, the price of which has soared in the past three years.

Investors have sought safety in this precious metal, pushing up its relative value as stock markets have tumbled and major economies have seen their currencies suffer and their sovereign debt written down.

A year ago, when the relative price of gold was approaching $1,200 an ounce, commentators were calling the top of the market. Since then gold has hit $1,921 an ounce (on September 6), although it has since dropped back to between $1,600 and $1,700; nevertheless, this is still a marked increase on $1,200.

The fact is that opinions differ as to whether gold has now peaked and we are currently in a ‘gold bubble’.

For example, HSBC Global Asset Management is predicting gold will continue to increase in relative value, rising to around $2,600 an ounce.

Contrarily, US bank Wells Fargo has stated strongly that it believes interest in gold investing has reached the level of “a speculative bubble”. The bank points out that when gold hit its all time high in January 1980, within two years its price had dropped 65% and it took until January 2008 – 28 years later – before investors who bought at the high broke even.

The increase in the price of gold has been fuelled over the past two years by investors looking to protect themselves against currency fluctuations, as first the US dollar hit problems and then the euro.

Gold has a unique role as a central bank reserve asset. This means it is increasingly seen as a currency. And with central banks pushing rates down to zero and printing money, no currency has performed as well since the spring of 2009, when the US Federal Reserve initiated its first round of quantitative easing (QE). If we see another round of quantitative easing and more money is printed this could see gold’s price pushed up even further.

The price of gold has also been boosted by the continued uncertainties in the global economy, reflected in stock market volatility. Investor reaction has been to invest in something immutable – primarily gold, but silver as an alternative – as a safety measure.

There are also other arguments for the price of gold increasing, namely the demand for gold, in particular as jewellery, among the rapidly expanding middle classes in India and China.

One problem with physical gold as an investment is that it doesn’t generate any income and it costs money to store. As such, it is, in effect, a depreciating asset. This is fine when the price is going up and investors can see a profit, but its value is only as strong as investor demand for it. At some time the global economy is going to start to recover. What we will likely see at that point is a rush of people wanting to move out of the previously perceived safe assets into those where they can make more returns.

It is easy to see what will happen. There will be more sellers than buyers, supply will exceed demand and the price will fall. However, the ongoing problems with European sovereign debt and the uncertainty around the US economy could keep the price of gold around its current levels at least for the foreseeable future.

Another aspect to consider, of course, is gold equities. Interestingly, while actual gold bullion has rallied, gold equities have been far more volatile over the years. The FTSE Gold index, which is designed to reflect the performance of shares in gold mining companies, rose around 16% during the year, but at time of writing lies some 50 points below its January 1 start point.

Some commentators point to a similar dislocation between the bullion price and equity performance during the credit crisis in 2008, which, as markets began to pick up, then saw gold equities soar and strongly outperform physical gold. But past performance is no indication of future returns.

Given the scenarios outlined above, at some point we can be certain that the price of gold will fall and it could do so quite dramatically. The big question is when.

So is it a good time to buy or sell gold? With widely differing views on the market, a lot comes down to the investor’s attitude to risk . Whilst gold is often thought of as a ‘safe haven’, the price volatility proves it is anything but. What we do know is that today is certainly a better time to be selling gold than three years ago, or, more notably, between July 1999 to March 2002 when Gordon Brown sold off most of the UK’s gold reserves at an price of $275 an ounce; close to the 20 year low!

:: Ian Lowes is managing director of Jesmond-based Lowes Financial Management


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