Investing in gold - the currency of fear

Many experts have different opinions on gold. While some of these experts feel the metal is only good as long as there are people who want to buy it, other experts feel like gold will always be valuable because of its "safe haven" status and the growing global debt problem.

RICHARD MEADOWS
Last updated 05:00 27/02/2012
The Timaru Herald

For thousands of years, human beings have had a primal attraction to gold.

With a powerful magnetism cultivated via legends, mythology and bloody conquest, gold inspires awe like nothing else.

And though it's been at least 40 years since our monetary systems were based on the otherwise unremarkable metal, some of us are finding it hard to shake off the allure of the shiny stuff.

Last year, the price of an ounce of gold soared to new heights of US$1889. In 2001, it was trading at US$271.

But as dazzling as that ascent may be, it holds no sway over Ben Brinkerhoff, general manager of Bradley Nuttall financial advisers.

Over the course of forty minutes, Brinkerhoff methodically strips gold of its mysterious charm until it resembles nothing more than an expensive paperweight.

"I'm not going to sit here and argue that gold hasn't gone up 500 per cent in the last decade- that's obvious to everyone", he says.

But what he does argue, and in no uncertain terms, is that investing in gold is a fool's game. Gold is not productive. It doesn't "do" anything. It lurks under mattresses. It moulders away in bank vaults.

"The only way I can make money in gold is for someone to buy it from me for more than I bought it for", he says.

Gold has limited utility - as a conductor or for jewellery - which drives some demand, but most of its value comes from hoarding.

Now, as uneasy investors turn away from ailing currencies and stagnant stock markets, the price of gold is going through the roof.

Brinkerhoff reads from a recent article by billionaire investor Warren Buffet in Fortune magazine: "What motivates most gold purchasers is their belief that the ranks of the fearful will grow."

"In some ways, the modern-day gold rush resembles a pyramid scheme. As the fear escalates and gold prices rise, investors own theories are validated through self-fulfilling prophecy.''

But the only way the price can keep rising is if more and more people buy in, Brinkerhoff says.

Gold provides no returns in terms of dividends or interest. Instead, demand is driven by perceived solidity in a sea of economic turbulence - gold is a metallic security blanket.

Brinkerhoff assumes his heartiest all-American salesman voice: "Have you lost money in investments? The one way to be sure of your investments having value, is gold. Gold Has Value!"

But if you look at the history of gold, that's simply not true, he says.

Between 1980 and 2000, for example, gold lost 80 per cent of its real value. Every $1 invested in the "safe haven" of gold turned into a paltry 20c.

There's a sobering lesson in there for all the get-rich-quick gold bugs. But don't be too quick to rub the gold dust out of your eyes - every story has two sides.

IN FOR THE LONG HAUL

Charles Drace sounds a little weary. The gold and metals branch of his company, Socrates Fund Management, hasn't performed well recently.

Drace's current woes are caused by the strength of the Kiwi dollar - or the weakness of the greenback. In US dollars, gold is through the roof, but in New Zealand terms, the current price is only slightly above where it was in early 2009.

But Drace is in it for the long haul and he certainly hasn't lost his faith in gold.

Socrates runs on much longer investment cycles then your typical managed fund- think at least 20 years.

As a self-described economic historian, Drace says there is often a negative correlation between share markets and commodities - when one is up, the other is down.

A quick history lesson: In the 1970s, general pessimism saw the price of gold rise more than 23 times over to a peak in 1980. After the crash, share markets began to steadily grow, culminating in the Dotcom bubble of 2001. Since then, gold has been on the rise again.

The point is, theoretically at least, gold is only halfway up the 20-year curve. In inflation-adjusted terms, it still has a fair way to go before it reaches the equivalent of that 1980 peak.

And this time round the euphoria will be much bigger, Drace says. The price might even hit US$8,000 or US$10,000 dollars. For that to be possible, he must be confident there will be enough fear to keep the foundations of the pyramid solid.

Drace says Europe, the United States and Japan will probably keep printing money like it's going out of fashion- and perhaps it is.

"The only way you can get rid of the debt is to inflate your way out of it."

Inflation devalues the major currencies, while adding value to the de facto currency- gold.

Gold has always been touted as a useful hedge against the spectre of inflation- it might not earn interest, but at least it's not going backwards.

But just how good a hedge is it? If you ask Brinkerhoff, pretty dismal.

The purpose of hedging is to reduce volatility, but gold is a capricious beast.

Using data from the last 35 years, Brinkerhoff says gold has a volatility of 19.27 per cent. To put that in context, his company's most risky portfolio has a volatility of 11.35- just over half.

What does that mean? For Brinkerhoff to use gold as an effective hedge, he would need to "have some idea predicting the fearful irrationality of human beings".

THE BIG PICTURE

Apparently, Kiwis are just as fearful and irrational as anyone else. New Zealand Mint did a steady trade in gold bullion over the last year, even through a third quarter dip in prices that had commentators screaming the bubble had burst.

Over the last 18 months, NZ Mint head of bullion Mike O'Kane has noticed that Kiwi buyers are starting to react to the bigger economic picture.

"Where we would see surges and dips based on the gold price, we're now seeing more demands over a long period of time that relates more to what's going on globally", he says.

For those that do invest in gold, bullion's tangible substance has a strong appeal. As O'Kane says when you physically hold a piece of gold, there's no risk that someone can spirit it away.

Compare that to "paper gold". There's a cautionary tale in the recent loss of hundreds of thousands of investor dollars in Bullion Buyer, now under investigation by the Serious Fraud Office.

Like anything else, it's all about doing your homework, O'Kane says.

"At the end of the day, the question isn't so much about the gold- it's about the people you're dealing with."

At NZ Mint, the most popular bullion is the one ounce Gold Kiwi coins, which currently sell for $2,271. Bigger denominations are available, but as O'Kane points out, forking out big money on an ingot that can't be split is not for everyone.

And if you want to avoid paying GST, says O'Kane, make sure investment gold is 99.9999 per cent pure- yes, to four decimal places. Anything less, and it counts as an alloy as far as the taxman is concerned.

But all of this ignores the obvious inconvenience- if you buy a big lump of gold, you have to stash it somewhere safe. The NZ Mint looks after some 20 per cent of its clients' gold, but where do people put the rest?

O'Kane: "Safety deposit boxes, mattresses, holes at the bottom of the garden."

He's joking, surely.

"To be honest, we don't ask", he says. "I've heard some stories which, quite often, make me shudder."

THE ALTERNATIVES TO GOLD BARS

Fortunately, there are plenty of other ways to invest in gold- enter David Wilson, investment strategist at NZ Funds Management.

Wilson is undoubtedly a believer- his company allocates about 20 per cent of its growth portfolios to gold.

"We do believe that it should make up part of [our clients] investment- but only part, obviously," he says.

NZ Funds Management invests in gold futures and gold mining companies. In futures, Wilson says, the only settlement risk lies with the exchange itself, rather than the counterparty.

On the production side of things, the company has holdings in New Zealand's OceanaGold and listed Aussie miner Kingsgate, among others.

The stock price of these companies is leveraged to the price of gold, but because they actually produce something and turn a profit, they tick the box for even Mr Gold-Averse himself, Ben Brinkerhoff.

Brinkerhoff freely admits his investment basket is full of golden eggs- companies that own goldmines, banks that own gold, investment companies with gold funds.

With stakes spread across 9,000 companies, he has no qualms about investing in the likes of gold miners. The fundamental distinction?

"These are businesses that have profits."

The one thing everyone agrees on is that gold cannot continue to rise forever and even if the bubble is only half inflated, it will burst.

The first to sell out, whether they're cautious and canny or just plain lucky, will cream it. To extend the analogy, these are the people at the apex of the pyramid.

If you bought 10 years ago, your profits over that time period would vastly outperform even the fastest rising stocks.

Those that buy in towards the end, or don't exit until later in the slump will not be so fortunate.

So we come to the $10 trillion question: when will gold peak?

"The point is, you don't know exactly how high it's going to get until such point as it does fall," says Wilson.

Brinkerhoff says the crash will come eventually- but he doesn't know when.

Drace's pick is between 2020 and 2022.

"My guess being literally as good as anyone else's- we're still a long way off the top", says O'Kane.

Gold timeline:

1961- The Reserve Bank of New Zealand sells the bulk of its gold bullion

1971- The end of the gold standard

1980- Gold peaks at US$875, or about US$2320 adjusted for inflation

1991- The Reserve Bank of New Zealand sells the last of its gold bullion

2001- Gold reaches a low of US$271

2011- Gold peaks at US$1889, before settling to around US$1700

2012- Gold price is trading at US$1777 as of late February

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