Smart Investor, Getting Started: November 2013

Smart Investor, November 2013

These have been lively times for investors in gold. An almost decade-long bull run apparently came to an end in 2012, having risen from US$320 in early 2003 to $1837 in July 2011. In particular gold enjoyed its greatest lustre through the global financial crisis, when investors sought stability in the oldest and simplest of assets: precious metal.

Gold is marketed first and foremost to investors as an inflation hedge, in that its value generally rises as the world economy – and the US in particular – inflates. It is also a diversifier. You may hear it said that gold does the opposite of the US stock market. That’s an oversimplification, but it is attractive for having very little correlation to equities, and so spreading risk in a portfolio. But there is something simpler that appeals to investors: it is tangible, very easy to picture, there is a finite amount of it in the ground, and it is indestructible. In volatile times, that is exactly what investors like to hang on to when other asset classes are uncertain.

Lately, though, its allure seems to have dimmed. After an up and down year, it climbed again to $1774 in August 2012 before heading steadily down to, at the time of writing, $1337. That’s a 25% decline in a year. This raises two questions: why is it falling? And is it a good-value time to invest?

One reason it is falling is because the global economy appears to be improving. Gold is the ultimate safe haven: people flee to it when everything else is looking bleak. This, more than anything, is what propelled it to its record highs in 2011, when the global financial crisis eased into the Eurozone crisis. As things have started to look better – US growth, European stability, bold Japanese monetary policy – so investors have edged back out of gold and into other asset classes.

But there are other drivers to the gold price too. It is influenced both by investment demand – those wanting exposure to the gold price, rather than necessarily having to hold it – and physical demand, which includes jewellery, coins and bars. Physical demand is driven chiefly by India, where gold is, among other things, an essential part of many marriage ceremonies, and a long-standing repository of wealth; and China, was increasingly becoming a powerful player in gold both in terms of demand and supply. While investment demand appears to be dropping back, physical demand is growing.

Also in the mix is a growing interest in gold by central banks, particularly in the Asia Pacific region.

So what next? The stimulus programmes in play around the world, and in particular US quantitative easing, have been seen as drivers of the gold price rally; speculation of an end to easing – and then Governor Bernanke’s comments in May that it would begin to taper off – have helped to push it back down again. And the September announcement that tapering would not be as fast as expected drove a brief rally in the gold price. Logically, that means that when tapering does take place – as it inevitably must at some point – gold will suffer again. This reflects a lot of analyst opinion: Citigroup says the gold price may fall below $1,250 by the end of the year, while Morgan Stanley expects a gold spot price to move between $1,200 and $1,350 over the next year.

But sooner or later, gold is going to have fallen sufficiently to represent good value again. How do Australian investors buy in when they believe that moment has arrived?

The easiest way is to buy an exchange-traded fund on the ASX. This can be bought and sold like any other share, but reflects the gold price. There are two of these available: one, ETFS Physical Gold, tracks the gold price in US dollars, and the other, from BetaShares, is hedged.

Why does this matter? Because it’s important to remember that when people quote the gold price, they are usually doing so in US dollars. For an Australian investor, that means there are two variables at play in their investment: gold itself, and the US dollar/Australian dollar cross rate. At times, these have been two very different things. An American investor in gold in 2011 would be looking back at better than 20% annual returns in five of the previous six years. But the US dollar fell sharply against the Australian dollar over that period, cancelling out most of the gains. So investors have a choice between a product that keeps movements in the currency as part of the investment – something they might favour if they think the Australian dollar is going to fall further against the US dollar – and one that neutralises the impact of the currency.

Another way of buying gold is in physical form, in bars or coins (or certificates), through the Perth Mint. There are also gold funds, like the Baker Steel Gold Fund sold in Australia through Select Asset Management, which combines global listed gold and precious metals equities – that is, the stocks of gold miners, for example. Or, investors can simply buy individual gold mining stocks directly on the ASX.

For each of these approaches, timing will be key. But investors do best with gold when they hold it for a prolonged period of time.