Gold: A personal view

Recent new highs in the gold price have brought it back to the attention of investors. But is it really time, at this late stage, to load up on physical gold like sovereigns, krugerrands and other forms of bullion?
 
It's worth taking a little time to ruminate on the course of the price of gold in recent years, and why it has behaved as it has.
 
Supply and demand for gold are only part of the story, although the recent price rise above $1,100 was undoubtedly sparked by the decision by the reserve Bank of India to swap dollars for gold by buying part of the bullion earmarked for sale by the International Monetary Fund, this both registering a vote in favour of gold and removing part of an overhang on the market.
 
But there has also been speculation that the move may prompt other central banks in emerging markets to increase their weighting towards gold as a reserve asset, with China's policy being the most watched.
 
I remember that the late Nils Taube, a veteran fund manager for whom I once had the pleasure of working, described the physical gold he held in one of his fund's portfolios as "an anti-dollar cash position", and that about sums it up.

Any UK resident holder of gold bullion very quickly becomes aware, when checking the price, that any upward movement in the dollar gold price is often offset, at least in part, by a reduction in the value of the dollar.
 
Nonetheless, one should perhaps add that gold has appreciated substantially in recent years in sterling terms, not least since HM government in its wisdom decided to sell the UK's gold holdings and, by telegraphing the move to the market in advance, neatly ensured that it got just about the worst price possible. In dollar terms, the sale was made at around a quarter of the current price.
 
As well as a statement against the dollar, buying gold to hold physically is an expression of more general distrust in the banking system. This is because gold is an acknowledged store of value and can be turned into cash for a known price more or less instantly, in contrast to the problem one might have selling other physical assets in times of panic.
 
We may think that, now that bank bail-outs have been put in place, the time to worry on this score has passed.

Yet the recent frisson in the market at the time of the announcements of further bank restructurings, and the fact that the underlying fundamentals of the toxic asset problems that the banks still have not been fully addressed or resolved, suggests that gold may have a further role to play as a safety first investment for nervous private individuals.

It is certainly true that while interest rates remain so low the opportunity-cost of holding gold is that much less.
 
Much has been made of gold's last peak in the late 1970s, when the price reached - at least on an intra-day basis - a high of $850 an ounce. Adjusted for subsequent inflation, this equates to a price in today's money of $2,200.

The more cautious among us might point out that using a daily, weekly or monthly closing price as the benchmark for the peak prices, produces an appreciably lower inflation adjusted number, but it is certainly true even on this basis that a price upwards $1,200 could be justified for gold again to display its true inflation-hedge status.
 
If inflation rises, with or without a rise in economic growth, gold may also again become attractive for that reason alone. So far the vast monetary expansion entailed by bank bailouts has propped up bank balance sheets and spurred securities prices higher rather than contributing to conventional consumer price inflation.

But a sharper uplift in the general price level may be around the corner if the extra liquidity is not drained away efficiently when it has served its purpose.
 
Before, however, we get gold's role out of perspective, it is worth saying that it is dwarfed in terms of market value by global bond markets. It is in effect a minor currency, but, crucially, one whose supply is fixed. Unlike currencies controlled by governments, it cannot be debased through use of the printing press. We have gold because we can't trust governments to do the right thing.
 
As gold has increased in attractiveness to investors, so the scammers have come out in force to take advantage of the unwary. So be careful that you are paying the right price. If you choose to buy physical gold, in the form of sovereigns or krugerrands, you should pay a premium of no more than 5-7% over the spot gold price converted into sterling at the current rate.

Currently that equates to approximately £650 per troy ounce. Sovereigns are approximately 23.5% of a troy ounce. In other words, four sovereigns roughly equate to one krugerrand.
 
Many sovereigns, especially the more recently minted ones, sell for no more or no less than their bullion content, but some of the older ones, from the era of George V and before, have substantial numismatic value on top.
 
One final note of caution. I once observed at a conference about gold that just as the British government's sale of its gold reserves marked the bottom of the market, so when governments started buying gold again it might mark the top. India's recent move is a small step in that direction. If other governments follow suit, it might just be an appropriate time to exit.