Some strange things are happening in the gold market – and I don’t just mean Wednesday’s fall through the US$1600 an ounce level.
Traditionally, investors have thought of gold as a store of value, a safe harbour in times of economic turmoil. The yellow metal has certainly lived up to that role in the GFC years, rising from US$734.30 an ounce when Lehman Bros. collapsed in October 2008 to an all-time high of $1,923.70 on September 6, 2011.
Since then, gold has lost 18%, as the US “fiscal cliff’ has been negotiated away and the European Central Bank’s “whatever it takes” motto has lessened concerns over Europe. But gold’s historical correlation to investor fear levels is not the whole story.
The yellow portfolio life jacket
It is easy to make the case that gold as a safe-haven investment does not have any intrinsic value itself – it merely serves as an inverse asset to fiat (government-created) money. When more money is being created, the value of that money falls, and the value of gold rises. That has certainly been the case in the “great reflation” that central banks have mounted since the GFC. Under this case, the advent of “currency wars,” or “competitive devaluation,” also plays into the hands of gold.
More recently, central banks have become the most significant factor in the gold market. According to the World Gold Council (WGC), central banks bought 534.6 tonnes of gold in 2012 – one-fifth of production – their highest level of purchases since 1964. For example, Russia’s central bank added 570 tonnes of gold in the past decade, making the country the world’s biggest gold buyer over the decade.
The central banks have been net buyers of gold since mid-2009. In particular, the central banks of emerging countries have been big recent buyers of gold, to diversify their reserves portfolios and to hedge themselves against what many see as irresponsible US and European monetary and fiscal policy. High-profile individual investors, such as George Soros and John Paulson, have done the same.
China’s growing gold appetite
Here, as in so many other economic factors, China is the most important factor. China is the biggest central-bank buyer of gold (although India as a nation still buys the most gold in a given year, mostly during the February-May wedding season.) China has not announced its official gold holdings since 2009, when it held 1,054 tonnes, but since then the People’s Bank of China has been buying plenty.
Chinese gold imports in 2012 more than doubled, to more than 800 tonnes, which is nearly 30% of global production, proving that China is accumulating huge amounts of gold. China has stated that it plans to have official gold reserves of nearly 9,000 tonnes by 2015, to back its plan to make the yuan an international reserve currency.
All of this implies that Chinese demand stands as a significant floor under the gold price.
Then there is the fact that production of gold is falling. Five years ago the average ore grade mined globally was 1.7 grams per tonne (g/t), but today it is just 1.1 g/t. The lower the grade, the higher the cost of mining the gold: and it is getting more difficult to find ounces.
The looming demand/supply imbalance – plus the ‘counter-weight to global money supply’ argument – are the main supporting factors for holding gold.
New ways to hold your gold
Many investment advisers recommend that a long-term portfolio such as an SMSF should hold at least 5% of its assets in gold, as the ultimate diversifier.
Gold investors have traditionally bought bullion itself, or on the Australian share market bought gold exploration stocks for a leveraged exposure to the gold price – as a company progresses a mining project from discovery to production, it can be significantly re-rated on the stock exchange. These days, there are far simpler exposures, in the form of the exchange-traded commodities (ETCs) listed on the Australian Securities Exchange (ASX).
The ETCs give you access to the gold exposure (as well as silver, platinum or palladium), custody, insurance and liquidity all wrapped up into one product. You can invest any amount you like, the management fee is low and you pay normal brokerage on both buying and selling, which you can get quite cheaply if you use an online broker.
The stocks simply track the A$ gold price, and may be sold at any time on the ASX. You can trade in gold as if you owned physical bullion.
Most ASX-listed ETCs are priced in A$, meaning that investors bear currency risk – the risk that an appreciating A$ tempers gold’s rise in US$. Some investors like this, because there is also the potential for the opposite to occur, and a falling A$ to magnify any rise in gold in US$. In 2011, ETF issuer BetaShares launched its Currency Hedged Gold Bullion ETF (QAU), which is hedged into A$.
Some people will always prefer physical gold, either ‘allocated’ bullion, which is stored individually in the investor’s name, or ‘unallocated’ bullion, which is stored in bulk and each investor has the legal title to the amount of gold they have bought. The Perth Mint and the Australian Bullion Exchange both offer SMSF-compliant gold investment vehicles, which cost more in annual fees than the ETCs.
Gold stocks disappoint
Lastly, there are the gold stocks, which have largely disappointed in recent years as their costs have risen. But gold explorers should be too risky a proposition for an SMSF investor to contemplate; while, like most miners, the gold heavyweights are not reliable dividend payers. Even the nation’s premier gold stock – Newcrest Mining (NCM), the fourth-largest gold stock in the world – is expected by consensus to pay an unfranked yield of just 1.4% in FY13 and a half-franked 1.8% in FY14. Newcrest CEO Greg Robinson says the company intends to lift its dividend – seeing it as a way that Newcrest can differentiate itself from the ETCs, with which it competes for investment.
Some of Australia’s smaller producers – the likes of Regis Resources (RRL), Resolute Mining (RSG), St. Barbara Limited (SBM) – can perhaps make a sound case as capital growth prospects, but the dividend, or lack thereof, should preclude them from SMSF consideration players.
It has never been simpler for SMSFs to hold gold exposure, through the choice of physical gold, listed entitlement to gold, and shares in gold-miners. Each avenue of exposure has its own attractions. Certainly the ETCs have the great advantage of liquidity and being able to accommodate any amount of investment. Bullion has that ‘sleep-at-night’ feel, but it has relatively high holding costs. And neither bullion nor the ETCs offer an income. For taking company risk, some SMSFs might see Newcrest shares as a better alternative to the ETCs: some income is better than negative income (i.e. annual management fees.)
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
