Investing in gold – it could surprise on the upside but it’s only for the brave

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There are few assets that divide opinion in quite the same way as gold. In fact the man considered to be the most successful investor of all time, Warren Buffet, said if Martians could see the way we behave around gold they would wonder what on earth was going on. After all, we dig it out of the ground, often at great expense in some far flung country, and then ship it to America, dig another hole in the ground, and have it placed under armed guard!

In the mutual fund space gold funds were among the very worst performers in 2013 (as well as 2012), with the worst-performing fund of all being MFM Junior Gold, which lost 64.73%*, while the gold price itself was down around 25%**. In recent years, the share prices of gold miners have diverged from the gold price, as the cost of extraction has increased, meaning many gold miners’ margins are coming under huge pressure and thus gold funds have substantially underperformed the gold price, with the sector down around 45%*** over the previous 12 months. This has led to the usual debate as to whether this presents a buying opportunity, or if the decline has further to go. To answer this question I thought it would be useful to analyse a couple of the drivers for gold price movements.

First and foremost, gold is seen as a store of value. It has been used as trading medium for thousands of years, largely down to its inert chemical properties and scarce supply. In modern times it acts as a safe haven, both in the event of geopolitical turmoil and as a hedge against the debasement of paper currency. While economic headwinds remain, the world is a relatively benign place at moment, and there seems little reason to park your money in an asset that doesn’t produce an income, especially in an environment of rising yields. I’m sure if a wider regional war broke out in the Middle East for example, or there is another financial crisis, that may change, but both of these scenarios appear unlikely in the short term but, admittedly, these types of event are notoriously hard to predict.

Then there is the spectre of inflation, for which gold is seen as the classic hedge. Historically, when central banks have printed money it has usually resulted in inflation and, with the huge quantitative easing programmes that several developed-market governments have employed, many industry experts were expecting this to lead inflation. In some ways it has of course, with risk assets seeing huge gains in recent years, but it is yet to filter down to wage growth. This has kept inflation relatively muted and has further contributed to the sell off in gold. I think the reason for this is that spare capacity and high unemployment have enabled businesses to keep wages down. Moreover, with our economic recoveries gathering pace, and unemployment on both sides of the Atlantic falling, it can only be a matter of time before it feeds through to wages, and then inflation. I know most economists aren’t predicting inflation at the moment, but how many of them predicted the UK would be the fastest growing large economy this time last year?

In summary, I’m not sure where the bottom will be for gold (it may not be for a year or two), and I realise there are arguments for and against the asset class, but if history is anything to go by, inflation may well surprise to the upside over the medium term and, if that is the case, gold will provide useful diversification in your portfolio which is in addition to gold equities being exceptionally cheap at the moment but, given recent performance perhaps only for the brave!

 

* FE Analytics 9/1/14

** FT website 9/1/14

*** Based on MSCI iShares Gold Miners ETF 9/1/14

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’ views are his own and do not constitute financial advice.

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  • https://www.wealthme.com/ John Advard

    Bravery is another thing we should not take high risks for our money. We should try to find such investments which have less risks and high chances of profits.
    VCT Broker