Alternative Outlook

History of Gold

Gold has been used as a tradable store of wealth for thousands of years. Gold has some unique properties that have made it ideal for this purpose:

• Its rare and difficult to extract, so it has scarcity value.
• it has a unique density that makes it easy to measure
• it malleable, so it can be easily shaped into coins or jewelry
• its ‘fungible’ – that means that one ounce of pure gold is the same another, which makes it ideal for trading
• It’s beautiful to look at, so it symbolizes wealth and power.

These qualities have meant that gold has always been used as currency and give gold its tangible, intrinsic value today.

Gold as a Safe Haven

Gold’s status as the world’s reserve currency makes it a great store of wealth in uncertain times. This is a pattern that has been repeated many times over the years – whenever there is a geo-political crisis or a downturn in the economy, gold performs well.

A look at the long term chart for gold shows how it works as an insurance against a crisis. The performance of gold peaked in 1980, when there were fears over the Soviet invasion of Afghanistan and the Iranian revolution, concerns over “peak oil” and the high oil price, concerns over high inflation and a weaker US dollar – all events that are still in the news today! The next, smaller peak was in 1987 after the stock market crash of “Black Monday”

Gold’s performance has been stellar since 2000. There have been numerous factors that have supported this, from the collapse of the Internet bubble in 1999, to concerns over a weaker dollar and higher inflation, to the Y2k bug, invasions of Iraq and Afghanistan and the global financial crisis in 2008.

We can also see from the chart that in more benign economic circumstances, such as those in the 1980s and 1990s, gold’s performance is flat or negative.

So perhaps the smartest way to think of gold is as a “crisis hedge”. As an asset that earns returns when you need them most – when all your other assets do badly – by holding some gold in your portfolio you can insure yourself against the worst impact of another market downturn or crisis.

The bottom line is that gold is money, and gold is the safest kind of money because it’s not tied to a specific country or currency. It’s liquid and its value is recognized worldwide.

What are the Fundamentals Behind Gold’s Performance?

There are five key fundamentals that are currently driving the gold price higher:

• The flight to safety from investors seeking a secure home for their wealth in the face of continued market uncertainty
• The weakening US dollar supports the gold price. Gold is an alternative to the dollar as the world’s reserve currency.
• Increased demand from central banks (one statistic that gold bugs get really excited about is the fact that BRIC countries only have approximately 5% of their reserves in gold on average, developed countries are closer to 50% so if the BRICs start to move towards the 50% levels there will be a huge demand for gold)
• Increased demand from the growing middle classes in India and China. There is a long tradition of saving in gold in these countries and their purchasing power is increasing as their currencies strengthen. Gold’s recent record high was partly driven by the demand for jewellery in India during the Diwali festival.
• No significant new discoveries. There have been no recent discoveries of gold of any significance and if there were there is a ten year lead time between making a discovery and getting gold out of the ground and onto the market. So we are not going to see a sudden increase in supply that drives the price lower.

Investing in Gold

There are a number of ways to invest in gold. These include buying gold mining shares, using derivatives such as Exchange Traded Funds; investing in a gold fund or actually purchasing physical gold itself.

If our view is that the smartest way to think of gold is as a “crisis hedge”, then owning physical gold fulfills that objective as it holds intrinsic value as a precious metal. It’s not a derivative or a paper asset; it doesn’t rely on an underlying asset to derive its worth; its value can never be zero. There is no counterparty risk, no liquidity risk and no management charges. Owning physical gold itself is simple, transparent and the ultimate way of owning a safe haven asset.

Exchange Traded Funds (ETFs) Warrants, Gold Funds and shares in mining companies, whilst giving investors exposure to gold, all carry these additional risks. This undermines the very reasons for owning gold as a crisis hedge in the first place! However, if you are interested in short term speculation, then these instruments are more suitable as they have lower costs.

In addition, purchases and sales of physical gold do not incur VAT, stamp duty or Income Tax in the UK. Purchases and sales of gold coins that are legal tender do not incur Capital Gains Tax. Therefore, PGL can review an investor’s investment objectives and investment criteria and advise on the most tax efficient way of investing in gold.

What is helpful to smaller investors is that gold is no longer something that only the rich or institutions can invest in. All of these ways of investing have low entry costs and low ongoing costs, so investing in gold is an option for everybody.

Key Reasons to Invest

There are four key reasons to invest in physical gold:

• Portfolio Insurance
• Liquidity
• Strong Performance
• Tax Free

We’ll expand on each in turn.

Portfolio insurance is another term for diversification. Gold is a strong performer in a crisis and gold does well when other, more commonly held assets such as equities and bonds do badly. There’s plenty of evidence for this: gold spiked higher after 9/11, during the build up to the wars in Iraq and Afghanistan and gold continued to outperform throughout the market downturn in 2008. So by having some gold in your portfolio, you can protect yourself against the full impact of another downturn or crisis. If you feel uncertain about the future direction of the markets, then you should be considering investing in gold.

Liquidity. There’s always a market for gold, so it’s a very liquid asset. You can liquidate your holding and realise your cash very quickly. Furthermore you can choose to liquidate your holding one piece at a time – there’s no need to liquidate the entire holding at once. This liquidity is one of the reasons gold is a great alternative to cash – especially in these times of high inflation and low interest rates. If you feel like cash deposited in the bank is performing poorly, gold could be for you.

Strong performance. Gold has returned 25% a year on average for the last 10 years. It’s up 25% this year at the time of writing having surpassed its previous record high of $1400 dollars and it’s almost unanimously forecast to go higher still. When you compare returns like these to the performance of other markets over the same period, they are hard to ignore.

Tax Free. Purchases of gold bullion in the UK are currently VAT exempt. There’s no income tax (as gold doesn’t earn any income) and gold bars are SIPP acceptable and therefore qualify for up to 40% tax relief. And if you invest outside of SIPP, UK gold coins such as Brittanias (containing a full ounce of gold) an Sovereigns (containing a quarter of an ounce of gold) are technically legal tender and therefore do not incur Capital Gains Tax.

Objections to Gold

There is one key objection that many people have in their minds – market timing. Many potential investors will look at the performance of gold over the last decade and ask “Have I missed the boat? Am I too late?”

There are four points that can be made in response to this

1.       The fundamentals behind gold’s strong performance are still in place.

2.       Gold might have hit its nominal record high, but adjusted for inflation that high would be about $2300 dollars so from this perspective there is some way to go yet.

3.       Gold provides portfolio insurance, so performance is not the only investment objective. The investment is also an insurance against another crash or market downturn, not just an opportunity for a quick buck.

4.       People were saying they had missed the boat 2, 3, 4, 5, 6 years ago and missed out on the subsequent performance! Timing the market is notoriously difficult: fundamentals and investment objectives should be more important considerations then timing.

Conclusions

In conclusion, you should consider an investment in gold because:

• Gold provides portfolio insurance in uncertain times
• Gold is a strong performer
• Gold is a liquid asset and an alternative to cash
• Gold is a tax free investment in the UK