Managing Funds: Gold a costly form of insurance

In times of market volatility, as now, investors rush to invest in gold.

Gold is quite easy to buy over the internet from several New Zealand companies and many overseas ones. I know some Dunedin jewellers will also sell you gold if they have sufficient surplus over their needs. The big problem with investing in gold is that it gives you no yield. That is, it does not earn cash while you hold it. To sell or not to sell is the big question facing investors.

The gold standard as monetary back-up was abandoned in the United States in 1971 and the Swiss were the last country in 1999 to stop using it as a currency guarantee.

In 1975, the price of gold in NZ dollars was $200 an ounce. The price spiked with the Gulf war in 1980 to $1100 an ounce, but rapidly dropped back to $400 by 1990 and did little until 2005.

There were several periods in there where you would have lost money if you had sold your holdings. By holding gold over the 30 years between 1975 and 2005, you would have earned no income and lost the opportunity to earn at least an annual average return of around 5% and as much as 12% in some funds.

Subsequently, since 2005, the price of gold has taken off to now be about $2200 an ounce. Much of this price rise is caused by lack of supply to meet demand, as little gold is produced these days and by buying and holding, investors are shortening supply. Those with vested interests suggest the price could get to $US5000 ($NZ6250) in a few years. This just causes a bigger problem in decision making.

Over the long term, gold is a poor investment, according to Australian company MLC Investment Management (MLC IM) strategist Michael Karagianis.

"Gold, of course, has gone from strength to strength and that is part of a 10-year cycle that we have seen gold continuing to appreciate," he said at the recent MLC IM Investment Summit 2011.

"People say: 'Is gold good value at this time?' Well, the issue with gold is that it is not necessarily a good long-term investment strategy. When gold stops rising, you don't make any money out of gold; there is no yield associated with gold.

"What it is, effectively, is an insurance policy. It is like insuring your house against a fire; you don't necessarily expect it to occur, but if the worst case does happen, this is where you want your money."

But Mr Karagianis said investing in gold made sense only for investors who expected a total collapse of the financial markets.

"If you don't believe the sun is going to rise tomorrow and you believe investment markets as we know them will come to an end, then gold is probably good value," he said. "But if you look at the period towards the end of the 1970s, after the oil price shocks, you spent a lot of time either losing money on gold or not making any money whatsoever. It can actually go into long periods of stagnation.

"It looks like a pretty expensive insurance policy at the moment."

There was an article in the Australian newspaper on August 20, about the former boss of Telecom, Theresa Gattung, investing $1 million in gold in 2007 and it is now worth $2 million. If she wanted my advice, I'd be advising that she sells at least half of it now.

In my opinion, the best way to be involved in gold is to purchase shares in a good gold-producing company. At least, that way, you are getting some income and if you purchase through a resources managed fund, you get the fund managers' research on which are the better-performing companies.

• Peter Smith is an authorised financial adviser and a certified financial planner and is the principal of Kepler Group Otago Ltd, Dunedin. Email: pete@keplergroup.co.nz. A disclosure statement is available on request and free of charge.