http://business.timesonline.co.uk/tol/busi...icle3211226.ece
January 19, 2008
Nervy investors must not rush in for fool’s gold
ROBERT COLE PERSONAL INVESTOR
GOLD hit new highs this week, breaking through the $900 mark. Its price has tripled over the past five years, putting inveterate fans of the yellow metal in investment nirvana. To judge by recent price performance we should all be gold bugs. Or are latterday converts to Atomic Element 79 nothing more than mugs?
The rapid increase in the price of gold is enough to create interest. In pure investment terms it matters little whether a rising price can be explained or justified. As long as you are on the right side of the contract, and get out while the going is good, the increase in value is the only relevant factor. If £1,000 becomes £3,000, and the change occurred honestly, who cares why or how it happened, as long as it happened?
Hindsight tells us that the dot-com bubble was an accident waiting to happen. Many suspect that the booming price of commodities – including gold but encompassing copper, coal and Brent crude – is a repetition of this history. But the key lesson for investors, surely, is to time propitiously the leaps on and off the bandwagon. The “greater fool” theory – which contends that any fool can buy and make money as long as they find a greater fool to sell on to – is apposite, and not just because it is easier to find fool’s gold than nuggets of the genuine article.
Sentiment, always a powerful investment force, may be felt, especially when it comes to gold. Its attraction has something in common with a currency. It is almost as liquid as sterling, or US dollars. Unlike greenbacks, either in folding or electronic form, gold is a “real” asset. People want it for itself, because it is glittery. Many like it for its enduring, almost mystic, qualities. To some, it is edible, many more desire it because it can be easily fashioned into pretty jewellery.
Gold is a sought-after investment safe haven in troubled times partly because, well, that’s just how it’s always been, and partly because it is inherently desirable. The sharp rises seen over the past five or so years can be accounted for by both these factors. First, because the Indian and Chinese industrial revolutions handed wealth to people who want to wear their good fortune on their fingers. As the Asian economies have emerged, so has the danger that the new commercial forces will destabilise the world economy. Gold has been sought as a refuge for those worried that globalisation will sour.
The credit crunch has helped the price of gold. Who would chose a collateralised debt obligation over a fistful of krugerrands when you have no clear idea what a CDO is, and less of a clue how to value one? Gold is an answer for investors worried that the Chinese and Indian economic miracles will fan global inflation. The answer to swinging foreign exchange markets, arguably, is auriferous.
However, investors tempted to view gold as a useful addition to the investment armoury must clamber over several large hurdles. The first is that gold pays no income. Investment lesson number one is that the capital value of anything is the sum of the future profit it generates, adjusted to take account of realities such as risk and the time value of money. You can value shares, bonds and property with reference to the income paid. Yield may not tell the whole story, but it is a terrific touchstone, not least because it facilitates meaningful comparison between investments of different asset classes. In the absence of income, the capital value of gold is questionable and can quickly become detached from reality. Indeed, gold is one of those assets that generates negative yield. Since it pays no interest, the cost of keeping it safe from thieves means that you have to pay for the privilege of owning the stuff.
Gold’s second problem is that it has few practical uses. Yes, it is nice to have and wear, and that gives it some intrinsic qualities. Gold has some industrial applications, in electronic circuitry, for example, in dentistry and, occasionally, as a food ingredient. About 12 per cent of the supply goes to these ends. But gold is nothing but a bauble compared with, say, platinum, which is used in large quantities in the manufacture of pollution-reducing catalytic converters.
The longer the price of gold stays high, the greater the incentive to find and refine ore. But increased supplies serve to weaken prices.
Finally, the global economic tensions that are driving the price of gold may prove more benign than the alarmists believe. At $900 gold has a way to go before breaching the inflation-adjusted $2,000 per troy ounce peak of 1980. But our economic ills are, surely, not nearly as deep. Sell.
