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Paul Lewis: Going for gold – but is it a good investment?

Paul Lewis 

Is gold an investment? Last week I would have been very tempted to answer “who cares?” as I fondled a kilogram bar a little smaller than an iPhone. The colour, smoothness and sheer weight of such a small object was totally seductive. “Yours for £28,250,” I was told. I was not in the market, just researching the new retail gold shop called Sharps Pixley in London’s St James’s Street. If I had handed over my debit card (and two separate forms of identification) I could have taken it away. Apart from the small matter of my overdraft, I am glad I did not because just two days later I would have found myself £500 poorer as the price of gold fell.

It does that, gold. Up and down like a fiddler’s elbow. So is it an investment? Many think so. The World Gold Council recently reported that demand for gold reached a 30-year high in the first quarter, driven by investors more than doubling their need, while use in jewellery fell by a fifth.

Gold is an odd investment. It does not produce a return. There is no income, no dividend, no interest. The American gold evangelist and author of The New Case for Gold Jim Rickards says that is because it is just money. A bundle of £50 notes produces no return either. Only when you lend it on deposit to a bank or buy shares with it or trust it to a company does your money make money. Gold, he says, is essentially cash, so no return should be expected.

In practice gold has a negative return. Unlike £50 notes you pay a premium when you buy it. That is around 1.5 per cent over the spot gold price. When you sell you will lose at least another 1 per cent. If you buy smaller amounts you will pay much bigger margins. A single gram will cost you £48 at royalmintbullion.com – a 75 per cent mark up on the spot price. Even at kilobar levels, just buying and selling the gold means the spot price must rise more than 2.5 per cent before you break even. Profits on gold bars are subject to capital gains tax though not VAT.

There is also an ongoing cost: storage. At home, such portable wealth will be well above your policy’s single item limit and many insurers will baulk at covering it outside (or even inside) a safe. Specialist insurer Hiscox would not give a price but told me: “We would query why the customer did not want it in safe storage. But if it was kept at home it would need to be in a safe.”

A safe deposit box at the Sharps Pixley shop costs £250 a year with another £75 for enough insurance to cover a kilobar, making the annual cost around 1.3 per cent of its value.

As with any commodity the chance of a capital gain depends when you buy and when you sell. A quick look at www.goldprice.org will show the massive volatility of gold over the short to medium term. The price peaked recently on 6 May at £28.72 per gram but as I write it is just £26.74. If I had bought then and sold now I would have lost 9.3 per cent of my investment after charges.

But as with any investment the last thing you should do is look day to day at the price and fret about it. In the long term, gold does have one big advantage over £50 notes: it does not feel inflation.

If you put those £50 notes under the bed, the inflation mice will eat away at them year by year. Over the last 20 years, prices have risen 71 per cent on the RPI measure. So each £50 note would be worth £20 less now. Over the same time, the gold price has risen more than threefold. Even allowing for the buy/sell spread and annual costs, gold has certainly beaten inflation over the last 20 years.

A common trope about gold is that an ounce will always buy a good suit – true from Roman times, through the Tudor era and into the 19th and 20th century. Today 1oz (troy) is worth around £835, so we are not talking Savile Row but nor are we in Primark.

Although gold is a good long-term inflation hedge, if you need the cash now the volatility may far outweigh the gain. Gold bought at its peak in September 2011 would today be worth almost 25 per cent less.

The alternative to gold bars is an ETF backed by physical gold. Seven Investment Management has six tonnes of it in an ETF – slightly more than the 5.9 tonne reserves of Lithuania. Charges are 0.25 per cent a year plus any platform or broker fees. Alternatively, you could buy shares in a mining company or, as Warren Buffet has, a bullion dealer. But where is the fun in that?

There is another downside to gold. Investors who care what their money supports might baulk at the conditions today in which it is extracted. The easy gold has gone. Today’s seams are either in remote and inhospitable areas, such as those mined by peasants risking their health and lives in the Peruvian Andes for a pittance. Or they require mass scale industrialised mines like those in Indonesia that pollute the local environment with as much tonnage of waste in a day as all the 161,000 tonnes of gold ever mined. Mercury, arsenic, destroyed rainforests and polluted waterways follow goldmining like evil wraiths. New gold is not an ethical investment.

But for many people, ethics and volatility are outshone by the sheer joy of owning the untarnishable, malleable and beautiful element 79, so they can wake up like Ben Jonson’s Volpone:

“Good morning to the day; and next, my gold:

Open the shrine, that I may see my Saint.”

Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programmeYou can follow him on Twitter @paullewismoney

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Comments

There are 4 comments at the moment, we would love to hear your opinion too.

  1. Sascha Klauß 2nd June 2016 at 2:27 pm

    I will start by saying that in fairness to Paul a lot of this article is accurate and good information, and if Joe Bloggs comes across this article while Googling “how i buy gould” it may save him from a bad decision. But I’m not sure what we the MM readership get out of it. Did MM ask him to write some basic facts about gold or is he just recycling random old articles that didn’t make it onto the BBC’s Moneybox website?

    “Even allowing for the buy/sell spread and annual costs, gold has certainly beaten inflation over the last 20 years.” – it would be more true to say that gold has certainly beaten inflation over the last *10* years. From 1996 to 2006 gold did comfortably worse than inflation. It did comfortably worse than burying your talents in the sand, for that matter, until the post-2000 rally finally undid the damage of the pre-2000 slump in 2005. So it is a mistake to think that gold has some intrinsic ability to beat inflation. It might. If you’re lucky. Same with any commodity. Or online poker.

    I’m quite fascinated by the stat that “an ounce of gold will always buy a good suit”. Fascinated by the fact that it is so inane and useless I’m not sure what drives people to repeat it as some pearl of wisdom. I imagine a bushel of wheat will always buy a pair of socks and a ton of granite will always buy a pet cat. And?

  2. adam mccormack 2nd June 2016 at 4:38 pm

    I had some similar thought to Paul an wrote this for The Shaw Sheet last week:
    All that glisters – may not be an investment
    Should you be hoarding gold?
    by Frank O’Nomics

    Beware – the gold bugs are back. After a torrid time, and a fall from the heady heights of almost $1900 per oz in 2009 to just $1050 late last year, gold has seen the start of a promising bull run, returning to $1250 per oz in the last 5 months. Gold tends to perform well when real yields are low (and they are currently so low as to be negative in many markets) and, as a typical investment cycle for gold lasts for around 3-5 years, this would suggest that the gold price has further to go. Should we then be adding gold to our portfolios? While there are always good arguments for adding something that increases portfolio diversification, the nature of the global economy and the greater availability of assets that may be a more rational alternative to gold may well mean that the current rally runs out of steam quite quickly.

    “Money is gold, everything else is just credit” said J P Morgan in 1912 and, for the 3,000 years that people have been investing in gold, it has worked well as both a currency and a store of value. In rough terms, it took the same amount of gold to buy a case of wine in Roman times as it does today (bearing in mind that Chateau Lafite did not exist 2,000 years ago), which is a lot more than could be said for the spending power of £ or $ over just the last few decades. Appetite for the metal remains on a rising trend, while mining it becomes ever harder – it takes twice as much ore to produce an ounce of gold as it did just a few decades ago. Asian demand is the significant driver of the market, with 1,400 of the 3,000 tonnes mined last year going to China and a further 600 tonnes to India. As the disposable income and savings of the population of these emerging economies develops it seems logical that this demand will increase further. Given this, should we expect a renewed assault on a $2000 gold price?

    In the short–term this may be an unreasonable expectation. The price has already rallied 20% from its low, yet physical demand for gold is down 10% year-on-year with jewellery related demand down 19%. The overall increase in demand (21% year-on-year) has largely been the result of buying by exchange traded funds (ETFs) which have seen significant inflows due to worries regarding the global economic landscape. Gold ETFs are a relatively new investment product which has made it easier for investors to gain exposure to gold, but the need for this exposure will have its limits. Slower growth in emerging economies is the reason for the slip in jewellery demand and the current outlook does not suggest an imminent resurgence. A further limiting factor comes in the way that investors typically try to profit from a gold price rally. It makes much more sense to buy gold shares than to buy an ingot or a Krugerrand, given the greater leverage gained by owning the equity. If a typical gold miner faces an all-in extraction cost of say $1000 per oz, then they will make $200 per oz if the price is at $1200. If the price increases by $120, then an owner of the metal will have made 10%, while the margin for the gold miner will have increased by 60%. Therefore, if we are bullish about gold we should buy the miners, but the problem here is that the prices of mining stocks have already seen significant increases. The largest gold miner in the world, Barrick Gold Corp, has seen its stock price triple since August of last year – a period over which the gold price is up around just 5%. On this basis, it would seem that we have either missed the boat for gold stocks, or that equity prices are somewhat ahead of that of the underlying metal and are relying on a further rise in its value.

    It is, however, in the longer run that gold as either a store of value or an investment vehicle can be questioned. Firstly, 52% of the demand for gold is for jewellery, with demand from central banks coming a distant second at 18%. From a jewellery point of view, India is the big buyer, but, from a savings point of view, as the market develops there it seems likely that there will be a demand for more sophisticated investments that produce a yield; this may be one factor behind last year’s fall in demand. Central bank demand is largely dictated by China – which keeps all of the gold that it produces. However, there seems to be no move to return to a gold standard to back currencies and, as the world becomes a safer place, the need to keep a store of gold as a hedge against geopolitical uncertainty seems less compelling for both governments and individuals. A number of developed nations have spent some time unwinding their gold reserves, notably the UK under the last Labour government, and there is scope for this to continue – a factor that could provide a significant long-term cap to the gold price. In short, it is dangerous to assume that the increase in demand for gold will continue in the long term.

    As for those who cite the correlation between with the performance of gold in an environment of low or negative real yields on the one hand and the constant real buying power of gold over centuries on the other, this argument only works over very long periods and there are now some adequate alternatives that will give protection from inflation. We have been in a long period of declining long-term interest rates, but it is only the period since the start of the financial crisis that has seen gold benefit significantly. If one looks at the 25 year period from April 1981, the gold price did nothing more than move sideways, oscillating within $100 either side of a $400 median, which is a very poor level of protection against inflation, however slight (and in the early 1990’s inflation was very high). Looking at a very long-term chart of the gold price, we would still appear to be correcting the significant price spike that the financial crisis created, a correction that could have much further to go. Amongst alternative defensive assets, inflation-linked government bonds have a coupon and maturity value linked to inflation, and the US version of these (known as TIPS) currently deliver a positive real yield (at least for those bonds with a maturity longer than 10 years).

    There is of course nothing wrong with buying your loved ones some expensive gold jewelry, and there may even be some cheap gold share out there if one can find those with mines that have a low all-in extraction cost. Either could prove to be reasonable investments in the very short or very long-term. However, this is a very different proposition to investing your savings for the benefit of your retirement or your children. The range of investment products has developed significantly over the last twenty years or so, and there seems little reason to be relying on a commodity that has little use beyond decoration, just because our ancestors did.

  3. Let’s start by looking at the figures over say the last 25 years. In January 1991 Gold was $390 and the pound stood at $1.90 (oh, heady days!).

    In January 2016 the price of gold was $1,078.41 and the pound stood at $1.4649
    In dollar terms this is an increase of 176.4% and in Sterling terms 258.75%. However, over the period Sterling depreciated 23% against the Greenback.

    The All Share wasn’t quoted in 1991 so at that time the FTSE 100 stood at 2504.1 and in January 2016 was at 6242.32 – an increase of 149.3%.

    Yes, I know you could have had other holdings outside the 100 and there are dividends to be taken into account. But: What has been more volatile? What is more tradeable internationally? Remember those who are refugees or escaping from unpleasant regimes (remember WW2) found Gold the most portable, tradeable and safest means of transporting wealth.
    I don’t advocate holding all your wealth in gold, but a decent slug will very often prove to be an advantage. As we approach the referendum are we sure that Sterling won’t take a hit? Wouldn’t a gold holding prove a worthwhile hedge? Sure, you can have mining shares or ETFs if that’s your bag, but when holding gold nothing beats some of the yellow stuff. You don’t have to trade it in the UK.

    As for the ethical considerations, I really do not follow. ETFs are based on the physical commodity, without it there would be no ETF – so where’s the ethical dividend?

  4. Julian Stevens 6th June 2016 at 9:37 pm

    Gold is an odd and unique commodity, the value of which varies perhaps more than any other on sentiment rather than fundamentals. It’s also worth considering that the vast majority of it resides permanently in places such as Fort Knox, having been extracted at great expense from one hole in the ground, then refined (at further expense) and deposited in another hole in the ground without ever actually being used for anything.

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