How long will gold remain the golden goose for investors?
The price of gold has soared in recent years, but experts warn that the bubble could burst all too easily
The price of gold has risen by 123% since early 2006. Photograph: Chris Collins/Corbis
The popularity of
gold has rocketed in recent years, reflecting the investor stampede to traditional safe havens at a time of extreme volatility in equity and property markets. The gold price has soared from around $550 in early 2006 to $1,227, a 123% gain compared to the drop of 5.4% in the FTSE100 and 4% in the Dow Jones Industrial Average during that time.
Predicting the price of gold can trick even governments into making mistakes. Gordon Brown famously lost out by selling large chunks of the UK's gold reserve between 1999 and 2002, getting a lowly price of between $250 and $300 an ounce – making his decision to sell a costly one. But investors with the Midas touch have made a fortune in recent years.
The
World Gold Council says demand for gold will remain robust during the remainder of 2010 as a result of accelerating demand from India and China, as well as increasing global investment demand driven by continuing uncertainty over public debt and the stuttering economic recovery.
But the WGC's mission is to stimulate and sustain demand for gold, and professional investors are beginning to think differently. Phillip Gibbs, manager of the £600m
Jupiter Absolute Return Fund, has recently sold out of his position in physical gold according to
Citywire,
while online trading news service DailyFX says the current rally in gold could be unsustainable, with the bubble set to burst at the first sign of weakness.
Ilya Spivak, DailyFX's currency strategist, explains: "Real gold demand looks decidedly lacklustre, with use of the metal for the manufacture of jewellery, as well as for industrial and dental purposes,
clearly tracking lower. The truth is that the rally has become self-fulfilling, with its appeal to investors dependent almost entirely upon its continued gains. It leaves the door open for a sharp reversal at the first hint of a meaningful setback."
Gold does not produce any income, interest or dividends and the price depends solely on demand and supply. If large institutional investors pull out, the risk is that retail investors who bought at the top of the market will be the ones who suffer. But what might cause a sudden decline in the gold price?
Most experts believe that low inflation or deflation would see gold stumble, though it is far from obvious what inflation will do in the coming months:
historically the price of gold has risen in line with inflation.
Will de Lucy from
Amplify Trading explains. "As governments have extended their borrowing there are concerns that some nations may not be able to sustain debt repayments in the event of another downturn, thus increasing the demand for safe haven assets away from government debt towards gold.
"Also, some countries, such as the UK, may also be faced with an inflation problem as well as growth concerns, further increasing the inflationary-proof investment of gold. We have seen significant price gains over the last 24 months but it would be dangerous to predict the bubble in gold being burst due to the above.
I think it is too early to expect demand for gold to subside."
Adrian Lowcock of
BestInvest says it is difficult to forecast inflation figures.
"Currently you can drive a bus through where experts believe inflation will be, but there are enough in the deflationary camp at this point of time, which will impact on the value of gold as the price will fall if we have deflation."
That said, Lowcock doesn't hold with the deflation argument and believes instead that there will be mild inflation.
Edward George, senior economist at the
Economist Intelligence Unit adds that even if the price falls by 20%, "we do not believe the price can fall below U$800/troy oz for long, as over half of current gold mining operations are only profitable at a price of at least US$1,000/troy oz.
If the price falls below this level for a long time they will simply stop producing, reducing supply and ultimately driving up the price again."
Spivak says any price reversal will be particularly dramatic because there are now so many exchange-traded funds used as a vehicle for gold investment, which makes gold positions much easier to liquidate. ETFs have become the default option for gold investors because they are so easy to use – you can trade
commodities, indices and sectors in the same way you trade a single stock – and sales are on track to eclipse those of actual bullion.
"The problem with ETFs is that, while they make buying gold comparatively easy, they make liquidating the investment easy as well, prompting a far more violent downturn than would otherwise be the case should trader sentiment reverse," Spivak says.
While many investors choose to access the virtues of gold via the equity market (either directly through listed mining companies, via collective funds or the exchange-traded fund market) –
investors have also been busy buying up actual gold in the last four years.
The
BullionVault gold store, owned by about 20,000 individuals, now looks after 21 tonnes of gold – exceeding the central bank bullion reserves of most of the world's currency systems including, for example, Canada (3.4 tonnes) and Mexico (3.5 tonnes). The company only launched in April 2005, but since January 2006, the value of client gold property has risen from US$9.1m (536kg) to US$833.5m (21.043 tonnes).
That said,
AWD Chase de Vere's Patrick Connolly, like most financial advisers, believes investors can get adequate exposure to gold and other natural resources through broad-based equity funds. "If investors are keen to increase their weighting, then we recommend funds such as
BlackRock Gold & General and
JPMorgan Natural Resources. Even then, because investors will have exposure through broad-based funds anyway, we would typically limit any specific exposure to a maximum of 5% of a portfolio."
BestInvest's Adrian Lowcock also recommends the Blackrock Gold and General fund for mutual fund investors keen to get in on any action.
Consumer awareness of the higher price of gold and difficult economic conditions has created increased demand for short-term cash, which has led to the rise of companies on the high street and online promising instant cash for your gold jewellery; though some of these
have been found to offer derisory amounts for cash-strapped people's heirlooms.
Pawnbrokers are cashing in. In the six months to 31 December 2009 (its last set of financial results)
Albermarle & Bond announced an increase in gross profits of 31% to £26.3m, in part due to a strong performance from gold purchasing.
David Bostock of pawnbrokers
Mays says one effect of the increased gold price is that the higher the price rises, the more customers can borrow. "We warn customers not to borrow more than they need. If they only require £300, there is no need to borrow £1,000," he said.
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