News & Blogs

How does Gold stack up in the current investment environment?

Tuesday 22nd November 2016

Let us take a closer look if gold has lost some of its safe haven appeal?

  • And there is a need to distinguish between holding the actual commodity and how you hold it, i.e. though futures exposure or in a physical ETF like GLD.
  • or whether you get exposure to gold by owning mining shares which often has a latent gearing factor with respect to the price movement of the underlying due to the fact that mining companies have varying amounts of debt whilst operating in the extraction of the physical gold, and mining companies can also be severely impacted by labour problems, insofar that they can be forced to stop production by labourers going on strike and even violence surrounding the strike action, forcing all workers to suspend work and halt the production of gold, whilst it is plausible that the underlying still increases in price due to production shortages.
  • And noting that gearing to physical gold(i.e. the commodity only and not the mine per se) is achievable if required by the investor as derivatives such as futures are highly leveraged, bearing in mind that most commodities, and especially gold can be extremely volatile at times.

Consequences of gold mining by way of example:

  • And gold enthusiast-investor appetite for gold as a safe haven asset has the inconsequential effect of ruining large swaths of countryside, let alone the weakening of earth’s tectonic plates and the mammoth task of analysing whether smaller quakes are purely mining induced, especially in deep underground mines, or natural tectonic shifts, or a mixture of both – an earthquake occurred near Klerksdorp, South Africa on 5 August 2014 (magnitude 5.5 on the Richter scale) and later investigation by the US Geological survey’s data put the depth at which the earthquake appeared at 4.1km below the surface, a strong indication that this quake was most likely mining related, as mining in that area occurs at up to 3.5km below the surface. According to the Council for Geosciences (CGS) in South Africa, this is the biggest earthquake in South Africa since the 1969 Tulbagh earthquake, and the biggest mining-related earthquake in South African history. This brings us to the costs involved: who should pay for the destruction caused, claims on insurance policies and subsequent increases in premium levied by the insurance companies carrying the exposure?

How does gold compare to owning a technology stock like Apple (AAPL) or a defensive sector such as tobacco:

Both these sectors seem to be important to defensive investors, and also investor with an eye on the longer term. It seems that a large proportion of investors feel the need(albeit a psychological need) to have some gold in their portfolios, usually a small percentage, but in some cases some investors are total believers in gold and invest heavily in the precious metal, citing reasons as a hedge or protection against inflation.

Gold has no dividends, doesn’t grow etc. and is currently priced in USD, which can potentially introduce foreign exchange rate risk for non-USD investors in gold but at the same time also serve as a hedge against your currency’s weakness. Industrial demand only accounts for about 55% of total gold demand meaning that the other 45% is just people who want to own it for some sort of investment value whether a central bank or you and me. Gold has however withstood the test of time. On a weight-to-weight basis, premiums on bars are generally lower than for coins, and this makes bars a more attractive proposition for the typical investor.

Depending on their purity, gold bullion coins can also be legal tender in their country of origin and normally bullion coins are available in both gold and silver with the exception of South African Kruggerrands and the Swiss Vrenelli which are only available in gold (see ISO currency code for gold XAU). Transaction costs in gold coins can be steep, and so to the costs of insurance and storage. Gold is however investable in numerous other ways, other than coins and jewellery, through ETF’s or derivatives on gold as aforementioned in this piece. Keep in mind costs vary due to many factors like the contango futures curve on gold or storage costs on physical gold and the relatively cost effectiveness of the SPDR Gold Trust(GLD).

Now let us just step back from gold and contrast with a technology stock as an example, perhaps gold beats a technology stock in withstanding thousands of years of ascribed value, whereas people constantly get bored with Apple’s latest product releases. But at least Apple (AAPL) pays a regular dividend, something you can measure against given a risk-free asset with a given yield, or at the very least debate its value based on yield calculations. Gold has no apparent yield other than value ascribed to it by inflation expectations and wild moves in the oil price impacting on inflation expectations, and a store of value in times of uncertainty, although this is not always so clear-cut.

Gold as compared to defensive stocks like British American Tobacco (BAT) or Imperial Tobacco (IMT).

It is an old adage that the tobacco sector provides shelter or protection against bear markets. And on top of this defensive attribute it also, among the blue chips, deliver steady yields normally, which again gives you a tangible benefit on which to assess the possible value of such a company. Of course there are some other defensive sectors as well, but they all contrast with gold in that these companies in these sectors normally yields a healthy cash flow plus the bonus of capital returns adjusted for inflation. So in companies we can value using expected future cash flows or dividend pay-outs.

Gold as compared to an investment in property or a REIT(Real Estate Investment Trust) is also odd as again it yields no income stream, nor does it have any intrinsic value in terms of use in manufacturing as opposed to something like platinum which has proven industrial application at present. And gold is used in jewellery but that does not drive price in a major way to the extent that platinum’s price is determined by the production of cars’ catalytic converters.

We can thus surmise that the only real value to be found in gold is that people place a value on it based on sentiment driven primarily for a fear of the future. On this basis fearless people will not give gold a second look!