Going for gold – 5 reasons to consider

The top performing asset class of the last decade was gold. Only toward the end of that period did ‘ordinary’ investors take advantage however, as routes to the market opened up. Now we see TV adverts every day looking for scrap gold and Harrods selling gold bullion, so is this a precursor for a classic asset ‘bubble’ prick? WAY do not believe so and here are five reasons why…

From January 2000 to December 2010 the return on gold was 277%, outstripping all conventional asset classes. Though a number of technical analysis readings suggest that the bull market will continue for a ‘second wave’, there is concern that the increasing populist aspect of the asset is indicative of a market that has run its course.

The latter is an understandable emotional response given what has been seen of some other asset and thematic cycles in recent times but the relative comparisons are difficult to match up. Consider the following:-

• GOLD AS MONEY

For centuries gold has stood as a proxy for or alternative to cash and its value has been historically reflective of that position. That descriptive changed in the 1980′s through 1990′s as disinflation became the universal goal and the returns from equities and financial assets were robust. Essentially, gold was re-classified in investment terms as a pure commodity. During this period gold fell from $850 per ounce in January 1980 to $252 in July 1999, a true bear market.

We now stand at a point where quantitative easing has been deployed by the major economies to the extent that the USA have printed more money in the last 15 months than they had run off since 1984 to that starting point. The global risk must become universal inflation of an accelerated kind and devalued paper money.

Gold’s re-rating in investors eyes as a cash alternative looks highly probable with such a backdrop, providing true support to price valuations. However probable, let’s not just assume inflation will be rife just because it supports the gold argument. Some economists are starting to forecast Japanese style deflation for the UK stating a moribund economy combined with stagnant credit conditions. Indeed there is substantial anecdotal evidence that for the first time in living memory that UK consumers are paying back debt. Here the Japanese experience is especially valuable, Japan as everyone knows has suffered the conditions described for the last decade during which time the Yen price of Gold has risen by 300%.

This is fairly conclusive evidence that Gold can also prosper in deflationary conditions as well. Furthermore a weak UK economy will tend to produce a weak sterling exchange rate (indeed it this trend has already started) and Gold & Gold assets offer UK investors a perfect currency hedge that comes without paying fancy fees associated with many structured products that attempt to offer protection against the likely decline of the pound.

• GOLD DEMAND

In recent times the supply and demand equation has been relatively simple and broadly equal. The tonnage of mined gold can be pair matched with fabrication demand, e.g. jewellery, dentistry, etc. Whilst additional supply from merchant bank and scrap gold sales has matched investment demand. The latter is increasing however, with China in particular swallowing up gold in preference to US treasury bonds. This looks certain to continue as the economy of the former continues to grow and, due to reasons mentioned earlier, the latter seem unlikely to prove attractive for some time yet.

• GOLD SUPPLY

Whilst demand grows it is unlikely that supply has the capacity to increase in line. South African fields are now 90% exhausted with, as example, the largest gold field ever discovered, Witwatersrand, now producing about 230 tonnes a year (10% of world production) down from its peak of 1,000 tonnes in 1970. Canada, US and Australia have further potential but this cannot be turned on ‘like a tap’. Additional prime to supply as in the 1980′s and 1990′s by the Western governments and banks selling off gold reserves has all but finished. The auction of half the UK’s reserves at 10% from the nadir in price – ‘Brown’s Bottom’ – being amongst the most unfortunate of disposals. So, growing demand and a supply mechanism struggling to keep pace should continue to underpin gold’s future prospects.

• GOLD, INFLATION ADJUSTED

There is twitchiness in the market about the current gold price despite the positive fundamentals. To a degree this is spawned by the wariness of commentators new to this asset class and more familiar with financial, particularly equity, markets. The $1000 threshold has been crossed and this is perceived as a neat high tide mark. However, at the peak of the previous bull phase in January 1980, gold was priced at $850 per ounce. Using the most conservative measure of US inflation the equivalent today would see gold trading at $2,300. With the current price not quite half of that figure it is easy to see why supporters eschew the notion that we are in a bubble. Rather, this is further evidence of the potential.

• RELATIVE POSITION TO OIL AND DOW JONES

To check the relative validity of the gold price it is helpful to check against other key measures. Another key commodity, oil, has had its own bull run, paused for breath, and is now moving upward again but the gold price is still sitting below its 40 year ratio of 15.1 relative to the ‘black gold’. It remains in the zone where arbitragers would be shorting oil and going long on gold. The current DOW/Gold ratio sits at 9.29. An 80 year check against the respective indices shows Gold peaking when within a 1-5 ratio of the equity index. With the DOW currently at 10,000+, this would indicate a target of $5000 per ounce! These relative comparisons are, of course, moving feasts but are a useful sanity check on the prevailing price.

For the ‘ordinary investor’ gold has seemed a little remote but the routes to investment have increased in recent years through additional fund offerings and ETFs. Inexperience will bring caution and perhaps fear that the gold race has already been run. However, with equity markets and bond markets having a far from certain near future, there does seem to be a strong case to further diversify investor portfolios and place a proportion in gold at this very juncture.

Eddie O’Gorman
WAY UK Head of Sales & Marketing
12th March 2010.

Posted on 12th March, 2010 | Tags: Gold |
Comments: Have Your Say