All roads to gold have their pitfalls, managers say

There is no single way to get exposure to gold, and each route has drawbacks consensus views suggest.

Investors have various ways to get exposure to gold, but each has advantages and drawbacks, and managers emphasise it is important to understand them all before investing.

The most direct path is holding the metal itself, but investors can also buy shares in gold mining companies, purchase gold futures, or more recently gold exchange- traded funds (ETFs).

Gold bars appear to be the route most taken by investors who made 390% doing this in the past ten years.

They can also invest with gold fund managers, or funds of gold hedge funds, such as Stenham Gold.

Its manager Jaspal Phull says holding physical gold traditionally worked as a hedge against inflation, including during the 1980s oil spike, as it does when money supply grows and threatens the value of paper currencies.

Since the US began doing this with QE1, the country’s deficit has rocketed 203%, he says, putting the US dollar under immense pressure. Meanwhile, the Federal Reserve’s balance sheet has expanded by about $1.8trn since 2009.

When the velocity of this cash flowing into the real economy increases, inflation is expected to jump.

Gold is a real asset that carries no liabilities. It can therefore hold its value in such circumstances, which is why people might prefer it rather than derivative investments in times of geopolitical stress, when values of other assets are under question. Holders made 5% in 2008, for example, while gold-related shares fell 40% or more.

Kenneth Rogoff, former chief economist at the International Monetary Fund, told a recent DWS Investments conference: “For high-net-worth investors, gold has a hedging function, not against inflation but against things being disastrous”.

“There is no reason for you not to have some gold. Its price in recent times compared to its 100-year average is very high and with emerging markets and other reasons you could see why it could be”.

“It does feel like it’s very high but that does not mean it will not go to $2,000 first. I wrote about it at $1,300, and it’s certainly gone higher since.”

Phull says: “If you want to protect against currency debasement you are better off in bullion, or benefit from equities that look undervalued.

“We want to make returns between those of bullion and the gold equity market, with less volatility than the equities, so we have to divide holdings.”

Gilt-edged Danger

But pure gold is not without dangers. Paula Bujia, manager of Schroders’ Alternative Solutions  Gold and Precious Metals fund, says she does not invest in physical bullion, partly because some investors face tax implications when selling it.

Phull adds that bullion can be cumbersome to store and insure, and it does not pay dividends. Gold mining shares yield a meagre 1% now, but Bujia says companies such as Newmont Mining, Barrick and Goldcorp have increased distributions to shareholders lately.

She suggests more could come because companies can sell each ounce for $1,524, whereas extraction plus capital expenditure costs them about $800 per ounce.

She says: “Cash is accumulating faster than they can spend it.”

Bujia adds gold mining shares should “give you some leverage to the gold price, through volume growth and exploration potential.”

Holders can also benefit if their holding is acquired, says Will Smith, senior fund manager at New City Investment Managers and adviser to its Golden Prospect gold equity fund.

“The grade of gold is in decline. It is cheaper and easier for managers in large-cap companies to buy deposits than to spend money exploring for new ones.”

He is looking to invest in companies that at least replace, and preferably grow, their production. Sometimes in the past, gold equities provided magnified exposure to bul- lion’s price. That changed this year.

Smith says: “Over the past three months, gold equities lagged the price of gold. The gold spot price rose by about 8% last quarter, while gold shares fell about 2%. The year to date tells a similar story.”

He attributes this softening to some investors preferring ETFs, some buying physical bullion and some generalist investors exiting mining shares.

This has left gold equities on attractive valuations, in his view. Average prices to net asset value in the sector have fallen about 30% over one year.

Phull says the investing environment is still risk averse, “and while gold prices have moved over the last 24 to 30 months, equities are looking extremely undervalued”.

Stenham’s chosen managers have about 60% of assets in gold ETFs and the rest in equities.

Smith adds gold equity investing carries risks, too, such as political dangers where companies operate in more exotic locations after the ‘easy gold’ elsewhere has been extracted.

Investors in equities must also be mindful of various factors, from availability of grid power to mining in remote areas, he says.

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