09 Oct 2012 Investing in Gold – THE RIGHT WAY!
When the financial crisis really hit the markets in August 2008 I advised investors to strongly consider investing 10% or more of their portfolios in Gold. It was my opinion that even if the Paulson $750bn plan worked to stabilize the money markets, the consequences will be dramatic and lead to a global recession. I personally sold all my shares, even in my pension fund, and held cash and Gold only. The Gold price increased by about 116% in both Dollar and Rand terms over the four years from Oct 2008 to Oct 2012, from $828 (R7,200) to $1,785 (R15,700). Several factors contributed to Gold’s resurgence:
- Investors lost confidence in global currencies and fled to Gold as a safe haven. Despite confidence returning to the US Dollar, with US Bonds preferred as a safe haven, Gold continued to attract investments as the ultimate safe haven. Private Investors piled into Gold ETFs and pushed total known holdings to 2,200 tons in September 2012 (Reuters).
- All the liquidity pumped into US, European, UK and even Japanese economies heighten the fear of higher inflation in future. It is my view that the US will welcome higher inflation to reduce their substantial debt. A study estimated that inflation of 5.5% per year can lower a country’s debt burden by 25%. That is, of course, provided that your foreign debt is denominated in your local currency, as is the case with all US debt. If not, the devaluation in the value of your currency as a result of higher inflation will negate the debt reduction effects. China, as one of the biggest investors in US Treasury Bonds, is rightly concerned that higher inflation will erode their investment.
- As interest rates globally fell close to 0%, the holding cost of Gold reduced considerably. Holding Gold ETFs or in bullion form earns no yield. When US Bonds earned a yield of 5% or more the holding cost was considerable. Now with 10 Year Bonds yielding only 1.6% the cost is very low.
I have stated the case for investing in Gold above, but I believe the right way is through an ETF and not Gold shares. In a normal investment environment, investing in Gold shares should always outperform investing in the ETF when the price goes up, because of the gearing effect of earnings. An increase of say 10% in the price of the commodity should lead to an increase of 20% to much more in the earnings of the share. The more marginal the mine (the closer its cost is to the current price), the bigger the increase in profits should be.
BUT… South African mining is not in a normal state.
Mines in SA and especially Gold mines have a very bad record of containing costs. Some of the blame can be laid in front of the mines, but there are several factors that makes investing in mines in SA very unattractive. Increased Government interventions in safety pushed up costs, legal strikes and recently totally illegal strikes even after wage agreements were reached, licensing ineptitude and corruption, continued talks of nationalisation is turning foreign investors away, soaring electricity costs and restrictions on capacity, and the list can go on and on.
When you invest in an ETF you invest in the commodity itself, already mined gold. The issuer takes the daily or weekly net purchase consideration and buys physical gold bullion. Another advantage of ETFs is that you do not have to pay for safekeeping as would be the case if you bought Krugerrands. None of the factors affecting a mine’s profitability will affect the ETF negatively because the gold is already mined. Many times those factors will lead to an increase in the price of the commodity, like spreading strike action is doing currently. Foreign investor selling of Gold shares will further weaken the Rand and so push up the Rand price of Gold. Foreigners do not invest much in our ETFs and even if they did it will not affect the price of the ETF because the issuer must ensure that the ETF tracks the underlying commodity in Rand. The issuer guarantees a buy and sell price.
This has never been better illustrated than the last two months. Newgold, the Gold ETF on the JSE, increased by 18% in value while the Gold Index of shares remained flat despite the increase in the Gold price. This was also true if one takes a longer term view and include dividends on Gold shares. From August 2008, when the financial crisis hit, to October 2012 the Total Return Gold Index increased by only 27% while Newgold increased by 127%.
– Gerhard Lampen
Head, Sanlam iTrade