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Different ways to play gold

There is a strong case to be made for gold. But what's the best way to get exposure?
June 17, 2010

Have investors missed the gold boat? A quick glance at the steady ascent of gold over the past 10 years, from around $255 an oz in 2001 (when Gordon Brown sold it) to a new high of $1,242 earlier in May, and you might well conclude we're in bubble territory. As Rupert Robinson, chief executive of Schroders Private Bank, points out: "Gold is setting record highs in almost every currency - and that's despite the strong dollar and monetary tightening in India and China, the main end markets for gold."

But viewed against the current backdrop of extreme economic uncertainty and currency instability, gold's enduring appeal as a safe haven is easy to understand. Many commentators believe it has considerably further to go in the coming months and years, pointing out that in inflation-adjusted terms, it's still below its early-1980s high.

According to the latest gold survey update from specialist consultancy GFMS, gold investment exceeded demand from jewellery manufacturers last year for the first time since the 1980s, as the combination of a bleak economic climate and rising gold prices dampened consumer demand for bling in key markets such as India and Turkey.

Investment demand is rising because people are worried about inflation, worried about deflation, and worried about currency instability. The huge sovereign debts hanging over Greece, Spain and Portugal and other countries threaten to undermine the viability of the euro, and investors also fears that significant inflation is set to return as governments print money to try to tackle their debt problems.

Gold's appeal lies in the centuries-old attraction of physical wealth in troubled times, explains Richard Davis, a fund manager in BlackRock's natural resources team. "The fact that gold bullion is a real asset, which does not depend for its value on any company or government, makes it compelling as a 'safe haven' investment," he says.

There's also the issue of supply, or lack of it. Big new gold mines have been thin on the ground over the past decade, while central bank sales have largely stopped, too - and some have now started buying gold to diversify their reserves away from dollars and government bonds.

The outlook for gold

So what is the outlook for gold? The consensus seems to be that although there may be medium-term corrections in price (caused by such factors as a strengthening US dollar and near-term concerns over deflation rather than inflation), over the longer term, the only way is up.

At fund management company Investec, Bradley George, manager of the Global Gold fund, maintains that $1,000 an oz will become the long-term floor for the gold price, and that "investment demand will force a peak that is nearer $1,300 an oz over the next six months".

Mr Robinson suggests that the gold price "could easily reach $2,000 within the next five years".

But sceptics suggest that the very existence of a consensus is a warning sign, and point out that prior to 2001, gold spent twenty years going nowhere. Lloyd Khaner, general partner of the US-based hedge fund Khaner Capital, cautions that the gold price will not continue upwards for ever, and that when the bubble breaks, it will break hard as people stop being concerned about inflation or sovereign debt. "If this is a bubble, and I believe it is, it might grow bigger, but at some point the negative feedback loop starts and the price will drop quickly."

Against that argument, the long-term growth in demand from emerging markets may help to underpin the price when investors do start to feel more bullish again. The World Gold Council is forecasting, for example, that Chinese gold demand could double in tonnage terms over the coming decade.

Diversity

Irrespective of where you stand on the issue of a gold 'bubble', the yellow metal remains an indisputably good portfolio diversifier owing to its low correlation to other asset classes and its tendency to perform well in either inflationary or deflationary environments. On that basis, the answer to the question "when should I own gold?" might reasonably be: "All the time."