Smart Investor – Acid Test, August 2010

Gold is at a record high and it’s easier than ever to get exposure. But should you?

1. Are you worried about traditional safe assets like bonds crashing? Yes/No

 One of the main reasons people invest in gold is as insulation against problems in other asset classes. In particular, since the problems set in with sovereign bonds in Europe, investors have started to think twice about what they used to consider safe haven assets. In an environment like that, gold shines: it’s at an all-time high in US dollar terms. That said, it’s very wrong to think that just because Greece might default on its bonds, you shouldn’t trust sovereign bonds anywhere else: some, including the US and Australia, remain pretty much bulletproof.

 2. Are you worried about inflation?

 Another reason people buy gold is as a hedge against inflation. Over the very long term it tends to move in the same way as inflation, so if you hold it, you won’t be left behind by the economy. That said, in recent years its performance has dramatically outstripped inflation, causing some to think it’s due a decline.

 3. Do you need diversification?

 Gold, like all commodities, tends to behave in a different way to stock and bond markets, and some advisors think that’s a good reason to include it in a diversified portfolio.

 4. Do you believe in gold’s outlook?

 Apart from the macro factors about the state of Europe and so on, there are simpler themes that impact the gold price. One is that there’s a finite amount of it in the ground – also that, once out, it is there forever in one form or another. It is affected by things like India’s growing wealth, given its popularity as jewellery there; by the difficulty of gold mining at increasing depths; and by central banks around the world wanting to hold it in national reserves. Most think the outlook, for the medium term at least, is good.

 5. Do you think the Australian dollar is due to weaken against the US dollar?

 In truth, few people do think this, but if it happened it would be good for Australians holding gold. Gold has performed sensationally in US dollar terms, but much of that gain has been wiped out for Aussies by the strong performance of their own currency.

 6. Are you comfortable buying something that’s already at a record high?

 An important question: some feel the great rise in gold has already happened and that we might even be heading for a bubble; others think that there is plenty of headroom. Gold trades at more than US$1,200 an ounce today; the most bullish believe it could hit US$2,000.

 7. Are you comfortable holding exchange-traded funds?

 There are several ways of owning gold: one is to buy an exchange-traded fund (ETF), like buying any share, which trades on the ASX and reflects the value of gold. Some ETFs around the world are backed by genuine allocated gold; others are just derivatives reflecting the price.

 8. Or do you prefer the security of owning something you can physically hold?

 If you’re so inclined you can get good old Goldfinger-style bullion or gold coins from the Perth Mint, who can also hold it for you or give you certificates reflecting ownership.

 9. How about gold miners?

 Some choose to play the gold price by buying the stocks of miners. There’s an awful lot more variables at work when you do this – you’re relying on their success to find gold and mine it, and a host of other issues common to any company – but they sometimes do better than the gold price itself. Some managed funds focus on gold miners and other ways of playing the gold price.

 10. Do you understand the dangers with gold?

 Gold can be volatile, unpredictable, and it will never pay you a dividend or earnings like a company does.

 The verdict

Mostly yes: There’s a place in your portfolio for gold, as a diversifier, a hedge against difficult times, and a plain old good investment

Mostly no: It’s not for you. Perhaps you doubt the outlook of something at a record high or think the Aussie dollar is going to wipe out any gains you might make.

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