Gold – In Bubble Territory or a Good Investment?

There is probably no other asset class where you hear such widely differing opinions from financial experts and fund managers as gold. Many are bearish citing the 12 year bull market and signs that quantitative easing and other central bank asset purchases are ending. QE is supportive of gold prices due to currency debasement and creating inflation. In addition with investors becoming less risk averse, rotation out of defensive assets and profit taking could send prices lower.  One estimate in an article I read from Investment Week, a trade paper, suggested the spot price of gold would fall to $1,000 per ounce by 2015. At the time of writing gold is priced at just under $1,600. At the other end of the spectrum some commentators predict an ongoing rally. One highly respected bond manager from Jupiter (the asset management company not planet) suggested gold could surge and hit $3,000 an ounce in 12-24 months! For mere mortals such as myself seeking to advise clients, it has been very difficult to form an opinion on gold, so I have been largely agnostic on it as an investment. Cue an excellent webinar I listened to yesterday from ETF Securities, a leading exchange traded product provider which certainly got me thinking.

ETF Securities provide exchange traded commodities (ETCs), tradeable securities for example that track the spot price of gold. These are backed by physical gold bullion deposited in secure vaults and are a way to invest in gold without taking physical delivery of metal. Arguably it is natural to expect a provider of ETCs to paint a positive picture of an investment they are marketing but they presented some excellent facts about gold I wish to pass on to my readers.

* The price of gold has risen four fold in the last decade, more than most other assets. You can understand the bears who think prices are high.

* In the last 10 years gold has achieved strong risk adjusted returns compared to other assets i.e. with low volatility.

* Returns from gold are often negatively or non-correlated with equities and other commodities. For example during the 20% worst periods for the S&P 500 (a leading US stock market index) in the last 10 years, gold and other precious metals produced positive monthly returns of just under 2%. In contrast losses were recorded on other stock market indices such as the FTSE 100 and commodities such as energy and industrial metals showing the high correlations between these asset classes. Gold is an excellent portfolio diversifier.

* Gold tends to outperform during financial crises and provides insurance for investors.

* Gold is an inflation hedge especially outside the 0%-4% p.a. inflation range. I expect inflation to surprise on the upside in the next five years.

* Growth in mine production since 2002 has been low, constraining supply.

* The cost of production of gold rose around four fold from 2002 to 2012 to just under $700 an ounce. This puts a floor on the price of gold.

* Central banks have gone from being net sellers of gold in 2002 to 2009 to net buyers in 2010 to 2012.

* China and India’s central bank holdings are very low as a percentage of reserves compared to the US, France and Germany. Demand for gold from China has risen sharply in the last 10 years.

* Now this was perhaps was the key point for me. The price of gold has risen by a very similar level to US debt in the 10 years to 31/3/13. US debt and debt to GDP ratio is set to rise in the next 10 years. The argument goes like this. Debt leads to expansion of central bank balance sheets, for example by QE and asset purchases. This increases money supply and hence currency debasement. As currencies weaken return for investors falls. In contrast gold is an attractive investment and hedge in contrast as it cannot be devalued. As long as economies remain indebted there is support for gold prices.

* The rise in the value of gold in the ten years to 25/3/13 is relatively modest compared to other asset bubbles notably the rise in the Nasdaq (a US technology stock index) between 25/3/89 and 25/3/06 and gold itself between 25/3/69 and 25/3/86.

In conclusion I have become more positive about gold as an investment and its inclusion within investment portfolios. However I am unlikely to recommend holdings in excess of 10%.

This is not a recommendation to invest in gold. You are however advised to seek individual advice before making investment decisions.