All That Glitters Is Not Necessarily Gold


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One of the hot investment topics of conversation at the moment is gold. It?s been a sought after commodity for centuries and has become even more popular as an investment asset over

One of the hot investment topics of conversation at the moment is gold. It?s been a sought after commodity for centuries and has become even more popular as an investment asset over recent years. This year it seems to be breaking records nearly every day.

But is there any value left in this asset class or is it overheating?

Gold offers both growth opportunities and defensive qualities. It tends to do well in times of uncertainty as investors move their capital to perceived safe havens ? and there is certainly a lot of uncertainty at the moment.

The Eurozone debt crisis won?t be resolved overnight and the US has some way to go to reassure investors, so it would be fair to assume that gold?s ascent is not over yet ? it wouldn?t surprise anyone if it hit $2,000 an ounce or more.

Nonetheless investors should exercise caution. Is gold really a ?safe haven?? We need to take a step back from all the hype and remember that gold is normally seen as a risky asset, one which is prone to short-term volatility, just as equities are, but unlike equities it historically offers meagre long term returns.

When you compare gold and international equities over the long term, gold has underperformed equities even with its recent popularity. Looking at the 30 years up to 31st March 2011, this includes 86 rolling 10 year periods of quarterly returns. Gold posted annualised returns of less than 5% for most of the 10-year periods. In comparison, the MSCI World Index posted returns of above 5% for the vast majority.

$100 invested in gold at the end of 1979 would have grown to $275 by 31st March 2011. The same investment in international equities, as measured by the MSCI World Index, would have grown to $1,817.

That being said, it?s hard to ignore gold?s current performance. On 16th August (I?m writing this on the 17th) it hit $1,783 an ounce ? a 28% rise from the start of the year and a 46% rise over 12 months. It?s understandable if you are tempted to try and share in the profits, but first ask yourself two questions: Is gold overvalued? Can it fall as dramatically as it can rise?

As legendary investor Warren Buffet once said: ?Be greedy when others are fearful and fearful when others are greedy?. Although gold will probably continue to rise for a while, I?d say we?ve arrived at, or are fast approaching, the time to be fearful.

If you look at 1970s and early 1980s, the price of gold shot up, reaching a record $850 an ounce at the beginning of 1980. For all today?s headlines telling us that gold is hitting new records, these are only nominal records. The real record (when inflation is factored in) remains that of 21st January 1980, which is $2,400 at ?today?s money?.

So what happened after this meteoric rise? Well, it was followed by a colossal fall. It had fallen 31% by the end of that year and 65% by 21st June 1982. It didn?t really start climbing again until 2001.

Most of gold?s long-term returns have come from very short boom periods ? just six of them since its deregulation in 1973, lasting between 4 and 22 months. This covers 15% of the period, so in other words it gave a less than stellar performance 85% of the time.

Gold has high levels of volatility. This means that it is, in theory, possible to make a lot of money in a short space of time, but likewise investors can lose a lot of money in a short space of time.

In summary, to make money out of gold you need to either be very, very patient or have perfect timing. If you don?t time the boom periods very well you risk owning an asset with a flat value over time.

To make the most profit you need to have bought early on and you also need to sell before it starts to fall ? and the problem of course is, how will you know it is about to fall? Like any other asset fortunes can change virtually over night.

While the price of gold may continue to rise in the short-term it already looks expensive. Its long-term prospects are not overly encouraging ? it does not provide an income yield and it has relatively few industrial uses.

Investing in broader based commodity funds within a diversified portfolio would offer more diversification, less volatility and better long-term prospects than gold on its own. It?s also interesting to note that as yet shares in gold mining companies have not risen at the same level as gold itself, so this could be an alternative opportunity to get exposure to gold.

Investing in gold is the same as investing in any other investment asset. You need to consider whether it is suitable for your objectives, circumstances, risk tolerance and time frame, and also how it fits in with the other assets in your portfolio. Remember that over exposing yourself to any asset carries risk, as does trying to time the market to make short-term gains. If you do include gold in your portfolio, I?d usually recommend it?s just a small part of a suitably diversified portfolio.

As with any other asset, I recommend you take professional advice from a wealth management firm like Blevins Franks before deciding to invest and the best way to do so.

By Bill Blevins, Managing Director, Blevins Franks

16th August 2011

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