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Gold shares outshine the real thing

According to Warren Buffett, all the gold in the world would form a 67ft cube worth $7trn. You can look at it, stand on top of it and declare yourself king, he says, but gold does not create value and therefore should not be a permanent fixture in a portfolio.

Since the late 1920s, gold has marginally beaten the Dow in capital terms but including dividends, shares left gold for dust. Consequently, equities generate wealth over time while gold maintains its purchasing power.

History teaches us that when there is confidence in financial assets, real assets are disregarded and vice versa.

During the bear market of 2000-03, the stockmarket halved and gold began its advance. From 2003-07, gold only matched the equity bull market but the diversification effects were once again illus-trated during the credit crisis, where gold held its value in 2008 as the stockmarket halved. In the subsequent stock-market recovery, gold has kept up yet again.

Meanwhile, if the present recovery is engulfed by an inflat-ionary surge, currency or the debt crisis, demand for gold will soar. To that end, we prefer gold over equities and bonds, as it has a habit of matching the return from risk assets during the good times and preserving capital during the bad.

The net effect of participating in the bull markets while avoiding the bears has led to a fivefold increase over the past decade with lower volatility, which is a better result than for emerging markets (including dividends) or even commodities.

Has anything beaten gold over the past decade?

Gold mining shares have blasted ahead but most of the performance was skewed to the first five years. Since 2006, the mining shares have lagged gold significantly and a substantial value gap has opened up.

Gold-rich nations such as Canada, Australia and South Africa have seen their currencies strengthen due to their robust commodity exports. Ironically, this so-called Dutch disease has choked their profits. Given these currencies are now seriously expensive, we feel any further progress in the gold bull market will feed straight through and result in higher profits.

Having participated in the gold market since 2003, we are reluctant sellers but on this occasion we see the switch from gold to gold shares as too compelling to miss.

It is worth noting that gold shares are essentially two-thirds shares and one-third gold, making them higher risk should the stockmarket fall. But given the compelling valuations, the margin of safety is better than it has been for a generation.

Charlie Morris is manager of HSBC Wealth Opportunities Service

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