From January to the end of May, the price of gold bullion jumped by nearly 8%, driven by the Greek sovereign debt crisis and resulting flight towards safe-haven assets, writes Castlestone's Angus Murray
Ignore the gold bears. The three key developments that drove gold bullion to a new nominal high of $1251 on 8 June – economic/geopolitical risk, devaluation of money and growing cost of production – are still going strong. With the price potentially heading towards the $1,400-$1,600 range by next year, gold remains an ideal asset to strengthen any portfolio.
Gold has continued riding the momentum built through the last decade, when the metal averaged an annual return of 15.19% versus -0.08% for the S&P 500. From January to the end of May, the price of gold bullion jumped by nearly 8%, driven by events like the Greek sovereign debt crisis and resulting flight towards safe-haven assets.
Contagion
Skeptics have hinted at the gold price hitting a ceiling, given recent highs have been followed by sell-offs. On the contrary, the sell-offs show us the economic contagion is continuing. With losses in equities slowly mounting, speculators are scrambling to cover these gaps by selling the assets that have turned profits, namely gold.
An investor who missed the gold rally might be thinking “why should I allocate now”? The fact is the episodes of economic/geopolitical shock gold protects against are not going away anytime soon.
Sovereign debt fears in Greece may have calmed for the moment but, like the US oil spill, many governments are finding it difficult to stop this nervousness from spreading. Downgrades of Spain & Portugal’s credit ratings have been followed by Hungary’s admission of its economy being “in a grave situation”. ‘Double-dip’ is quickly entering our lexicons. With the slow summer months around the corner and little resolution in sight, portfolios need protection.
Protection
Having an allocation to physical gold before such events occur provides protection when it is needed the most. 2008 is a good example – while the S&P 500 plummeted by 37%, gold held steady and delivered a 3% return. Gold also protects against the economic knock-on effects of geopolitical events. The week North Korea announced its intentions to prepare for conflict against South Korea, for example, gold rose by 1.6%; the metal has rarely stopped climbing since. If the flights to safety continue, the price of gold should keep rising.
Another reason to allocate to gold now is the devaluation of money is set to accelerate in the short and medium term. Central banks are increasingly printing their way out of financial trouble and letting the value of their money depreciate. The ECB has not officially gone down the quantitative easing route but you can bet its €750bn plan to support ailing countries by has helped drive the euro down to its lowest rate against the dollar since March 2006.
Gold’s insurance quality also kicks in during this scenario, as the price of the physical metal rises when the value of money decreases. Many institutions that traditionally shied away from commodities, are increasingly adding gold and other real assets to curb the effects of devaluation.
Finally, the increasing costs of gold production worldwide could translate to higher prices for the metal. According to precious metals consultancy GFMS, the cost to produce an ounce of gold increased by over 150% between 2003 and 2008 and hit a new high of $478 in 2009.
The price of gold
There is plenty of gold left in the world but the technology and resources needed to dig it out are becoming more costly. Ultimately, the price of gold will have to rise for these mining companies to be economically viable. If it does not, many mines could shut down which would decrease supply and potentially increase the price.
Coupled together, these developments should make gold bullion a strong performer in this decade. While we may not see another decade of double digit annualised returns, a 6%-8% return per year is a real possibility. A 10%-20% allocation to physical gold is ideal, as it offers maximum portfolio protection in bear markets and should benefit from rising gold production costs in bull markets.
There are many ways to get exposure to gold but only gold bullion enables investors to reap the maximum protection against economic contagion. Investors must also be aware of currency exposure, especially if they put sterling into an ETF that buys gold in dollars. We recommend looking for a gold bullion fund with a hedged currency share class.
The bouncebacks in the gold price after recent sell-offs show that investors are not letting opportunities slip through. Chances to snap up gold at $1,250 may be few and far by the end of the year.
Angus Murray is CEO of Castlestone Management
