Gold: The eternal currency

A VERY INTERESTING READ ON GOLD FROM AN ARTICLE IN BUSINESS TIMES, PLEASE GO THROUGH

Gold: The eternal currency

It is the favoured asset class in both inflation and deflation scenarios, even though in the latter case, it will not make a lot, but it will be better than equities

By GENEVIEVE CUA
PERSONAL FINANCE EDITOR

IN early 2000, strategists who recommended a holding in gold would have been up against scepticism.

Today, advisers are calling on investors to buy gold, never mind that it has seen a decade of outstanding returns. Since 2000, gold has delivered an annualised return of 16.09 per cent in US dollar terms, against the S&P 500 returns of minus 0.81 per cent.

Returns were even more robust in the last five years: Gold's annualised return was 23.88 per cent; against S&P 500's 0.31 per cent.

Says Pictet group managing director Yves Bonzon: 'We introduced gold into our portfolios at US$320 an ounce around 2003. We've been bullish since. We think the bull market will last until 2015. Our target for gold is US$2000 minimum, equivalent to five ounces of gold per unit of Dow Jones Industrial Index.

'If inflation is the way out of the debt problem that the West faces, the upside - depending on inflation - can be substantially higher.'

The firm invests in physical gold rather than through exchange traded funds, to avoid counterparty risk.

Julius Baer chief investment officer Van Anantha-Nageswaran told clients last week: 'As insurance, don't have second thoughts about the role of gold. Load up on gold up to 10-15 per cent for the next two to three years. As countries compete to keep their exchange rates weak, you don't have too may options . . . The best news for gold is still ahead of us.'

Gold currently trades at about US$1244 per ounce. In roughly about a year, it has appreciated by 37 per cent from US$908 in July last year.

While Europe's debt crisis and the resultant weakness in the euro have been almost immediate and obvious underpinnings to gold's rise, worries over an unsustainable US budget deficit and the spectre of inflation have been an almost constant refrain in the last few years.

As a recent article in the New York Times says, gold buyers have always been motivated by fear. 'What has changed is that some of the most respected investors on Wall Street are now among the fearful.' Hedge fund manager John Paulson, who made billions shorting sub-prime mortgages, holds US$3 billion of gold ETFs. Gold is his largest position in his US$35 billion portfolio, says NYT.

Pictet's Mr Bonzon argues that gold is the favoured asset class in both inflation and deflation scenarios, even though in the latter case, it 'will not make a lot, but it will be better than equities'.

While the eventual outcome of inflation or deflation is debatable, gold as an alternative currency may well be the most persuasive argument. Mr Bonzon says: 'In the first few years, we spent years explaining that gold is not just a bearish bet on the dollar, but on all paper currencies. It's a currency that (central banks) do not have the printing presses for. That's why (we) like gold.'

In a paper 'Gold - the ultimate currency' published recently, UBS offers insights into the valuation of gold and its investment outlook. The popular view of gold as a commodity, it says, is too limiting and fails to explain gold's behaviour.

'Gold is money - a very special form of money. It is gold's monetary function that drives its price beyond its relative value as a commodity . . . Applying a valuation to gold is tricky. There is no absolute independent measure that determines when gold is cheap, expensive or fairly valued.'

Based on production costs, gold is not cheap, says the report. But compared to other assets such as oil or stocks, 'gold appears to be at least fairly valued if not inexpensive'. The stock-to-gold ratio is one yardstick that is often cited, for instance. In 1900, the ratio was two - that is, it took two ounces of gold to buy the whole Dow Jones Index. It remained below five for the next 25 years, and then shot up to 15 during the market boom of the 1920s.

With the US in recession in 1980, that ratio fell to one. It picked up speed in 1990s and during the technology bubble, was an astonishing 35. Since then the ratio has been falling to its current level of about eight.

'Given that the long term average price of the Dow Jones Index is 5 ounces, gold is still somewhat cheap compared to stocks, which is the same as saying that stocks are still somewhat expensive compared to gold.'

'We think that the price of gold has yet further to rise. Our target is about US$1,500 per ounce in 12 months time. Of course, any sharp intensification of the sovereign debt crisis in Europe could propel the gold price even higher, but the downside risks should not be discarded lightly either.'

The firm says any dip below US$1,200 is a buy. 'We would expect investors to be richly compensated for the risk they take.'

UBS' report also advises investors on their approach to gold. Investors, it says, should be clear about why they want to invest in gold. There are typically four considerations - portfolio diversification; thematic exposure through structured notes; yield enhancement using options; and opportunistic trading. Those objectives will exist alongside varying investment horizons.

It favours direct investments in gold rather than mining shares. A higher gold price may not have a strong impact on a company's share price. Shares are also affected by the broader market, as witnessed in the steep drop of mining shares in 2008.

In a portfolio, it does not advise allocations of more than 10-15 per cent in the long term. 'Even though the correlation with equities is rather low, especially in difficult investment environments, gold fails to deliver adequate returns over a multi-decade investment horizon. An allocation of more than 10-15 per cent harms the historical risk/return profile of a balanced US dollar portfolio.'

There are of course, risks to gold. High real interest rates, for instance, could trigger outflows out of gold and a fall in price, it says. For now the likelihood of this is believed to be low, given a still fragile economic backdrop.

In Singapore, buying physical gold incurs GST. There will also be custodian charges at banks. The most accessible way may be through SPDR Gold ETF listed here.

Copyright © 2010 Singapore Press Holdings Ltd. All rights reserved.

 

 

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