|The Bahamas Investor Magazine
June 23, 2009
June 23, 2009
Interest in gold has soared among private investors in recent months, as a financial crisis has created a demand for traditional safe havens. For the high-net-worth individual (HNWI), the case for gold is particularly compelling. Moreover, the advent of gold exchange traded funds (ETFs) means that accessing the gold market has never been easier.
Gold is a unique financial asset in that it has no counterparty risk. Its lack of correlation with other mainstream financial assets also means it can help diversify a portfolio and boost risk-adjusted returns regardless of the health of the financial sector or broader economy. Gold also has a long history as an inflation hedge, outperforming bonds and equities in high inflation years.
The deterioration in global economic and financial conditions triggered a surge in identifiable investment demand in gold in the third quarter of 2008, to 382 tonnes—up 179 per cent from the previous quarter and 56 per cent year on year. Gold ETFs, securities traded like a stock but backed by physical gold, enjoyed record inflows of 150 tonnes during the quarter. The peak came in mid-September following the collapse of Lehman Brothers Inc, when holdings surged by an unprecedented 111 tonnes—the equivalent of $7 billion—in five consecutive trading days. At the same time, retail investment in bars and coins rose by 121 per cent, to 232 tonnes.
Gold’s lack of counterparty risk was no doubt a factor in the steep rise in demand, but its lack of correlation to the mainstream financial market also made it stand out.
This lack of correlation between gold and other assets reflects the unique drivers of supply and demand in the gold market. These include exploration spending, mine production, producer costs, producer hedging, seasonal demand in the jewellery sector and changes in official reserve holdings.
These unique drivers mean that changes in the gold price do not correlate with changes in US economic growth either. Since the gold price was fully freed in 1971, there have been times when gold prices have fallen as the economy slowed and times when the reverse is true. This suggests that the current recession will not necessarily have negative implications for the gold price.
How to buy gold
The gold market is deep and liquid and can be accessed by HNWIs in many ways. Perhaps the most obvious is to buy investment coins or small bars, available from bullion dealers around the world. Investment coins need to be distinguished from numismatic coins, whose price may include a premium due to their rarity or collectability. Coins and bars are also available in a variety of weights and sizes, ranging from 1?20 ounce coins up to 400 ounce gold bars.
Gold bullion banks also offer “gold accounts.” When a customer orders gold, the bank will buy it on their behalf and book it to the account electronically. These accounts come in two forms: allocated and unallocated. In an allocated account, the gold is stored in a vault that is owned and managed by a recognized bullion dealer or depository. Bars or coins are numbered and identified by a hallmark, weight, finess, and allocated to each investor, who pays the custodian for storage and insurance. The holder of gold in an allocated account has full ownership of the gold and the bullion dealer or depository may not trade, lease or lend the bars except on the specific instructions of the account holder.
In an unallocated account, investors do not own specific bars or coins. Traditionally, this has the advantage of incurring no storage or insurance charges because the bank reserves the right to lease the gold out. But this means that the investors are exposed to the creditworthiness of the bank or dealer.
Gold ETFs are the newest way to buy gold. These combine the flexibility and ease of equity trading with the security provided by an investment in physical gold. There are several gold ETFs listed on stock exchanges around the world.
The largest is SPDR Gold Shares, GLD, which is listed on the NYSE/Arca platform. SPDR Gold Shares represent an undivided beneficial interest in a trust, the sole assets of which are gold bullion. The shares are designed to track the price of gold, minus the expenses of administering the trust. The shares are 100 per cent-backed by physical gold bullion, which is held in 400-ounce London Good Delivery bars in an allocated account in the London vaults of HSBC Bank. The fact that the gold is held in allocated form is one reason why GLD—like physical coins and bars—has proved so popular during the current credit crisis, as investors have balked at the idea of any form of counterparty risk.
Gold certificates also offer investors a method of holding gold without taking physical delivery. Issued by individual banks, particularly in countries like Germany and Switzerland, they confirm an individual’s ownership while the bank holds the metal on the client’s behalf. The client thus saves on storage and security issues, and gains liquidity in terms of being able to sell portions of the holdings by simply telephoning the custodian.
Banks also offer a number of structured products on gold, while commodity exchanges offer futures and options. Investors can also gain an exposure to movements in the gold price by investing in gold mining equities directly or in gold funds. Gold funds are likely to differ in their structure. It would be misleading to equate investment in a gold mining equity with direct investment as there are some significant differences. The appreciation potential of a gold mining company share depends on market expectations of the future price of gold, the costs of mining it, the likelihood of additional gold discoveries and several other factors.
Gold has been valued as a global currency, a commodity, an investment and simply an object of beauty for thousands of years, but its unique investment characteristics make it just as relevant for today’s investor as it’s ever been.
Natalie Dempster is head of investment North America at the World Gold Council. She has a background in investment banking and has worked as an economist at both the Royal Bank of Scotland and Chase Manhattan Bank, where she also worked as a foreign exchange trader. She holds a BSc in Economics from Queen Mary and Westfield College, University of London and an MBA from City University Business School (CASS), London.