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Business Times - 13 Jun 2011

Understanding the shiny allure of gold

MINDY TAN takes a look at the various factors budding investors should take note of before taking the plunge

I DARE say, you might never look at your grandmother's gold necklaces, rings, and accessories in the same way again. While (yellow) gold seems to have lost some of its lustre within fashion circles, gold as a commodity still retains its charms in the world of investments.

When this love affair began 5,000 years ago, gold was primarily used for adornment and worship. It wasn't till much later that gold was made into coins. While this enhanced its usability as a monetary unit, it was not a perfect solution since these coins were often collected for the sole purpose of accumulating enough gold to melt them down into bullion.

Believe it or not, bullion is still one of the ways you can gain exposure to gold. Other ways include investments via an exchange- traded fund (ETF), index, or trading of futures and options in the commodities market.

Given the fair amount of emphasis placed on futures and options previously, let's take a closer look at the other investment vehicles available for gold.

Physical assets

Is investing in gold as a physical asset a good idea? Sam Goh, wealth coach at Wisdom Capital, suggests that it might be, but only to a certain extent.

'Having investment exposure in physical gold may probably be the most secure way to invest in it,' he says. 'Another major reason is its wealth preserving powers, as gold is unlikely to lose its intrinsic value unlike other paper currencies. Most importantly, investing in physical gold is an effective approach to hedge against inflation and economic crisis by serving as a form of 'insurance'.'

On the other hand, investors who dabble in physical assets have to tackle security and liquidity issues. In addition, investors can only look forward to potential capital gains, with no dividend options.

'For investors who are looking for regular streams of dividend income, investing in physical gold may not necessarily be a good idea (as) physical gold does not offer any dividends (but instead) potentially offers capital appreciation,' Mr Goh adds. 'This is clearly a downside that investors will have to take note of if they are dependent on dividend payments to finance further investments.'

Gold index

Commodities and precious metals have traditionally been benchmarked and priced against the greenback, according to Mr Goh, resulting in the gold price reflecting fluctuations of the US currency rather than actual shifts in the fundamentals of gold.

To counter this, the SPM Gold Index is measured against a basket of 11 major currencies, which are equally weighted. The 11 currencies in this basket represent countries that play a major role in the global supply and demand of gold by their capacities as producers and/or consumers.

'In this case, it is a worthwhile consideration for investors as the SPM Gold Index will serve as a more relevant and objective benchmark for them to monitor their existing gold investment holdings and track their performances,' says Mr Goh. 'The index will also allow them to spot trend patterns and identify any fundamental shifts in gold more accurately and objectively.'

Exchange-traded funds

Gold ETFs on the other hand allow investors to buy into a fund that is backed by physical gold, and/or gold futures. The buyer may choose to sell the futures at any time, hence hedging their risk of holding cash.

'One of the key highlights of investing into gold ETFs is that it offers liquidity to investors should the need arise,' says Mr Goh. 'Investors can exit their gold ETFs position in the financial market very quickly without much hassle.'

'Another key advantage is storage. An investor does not have to fret over any potential storage issues (including monetary issues that may arise through fees paid to insure physical gold),' he adds. On the other hand, the prices of gold ETFs rarely match gold spot commodity prices, says Mr Goh, adding that they are usually lower.

'(Before going into ETFs), investors should seek to understand how these ETFs function and what are the advantages and disadvantages offered to determine whether or not they are appropriate for their needs and investment requirements,' Mr Goh says.

All that glitters is not gold

James Bond fans may remember the scene in Goldfinger where the gold-obsessed villain watches as a laser inches toward a restrained James Bond who is secured to a gold-topped table. Before he leaves, he says: 'This is gold Mr Bond. All my life I have been in love with its colour, its brilliance, its divine eminence.'

While movies like this, including others with gold-obsessed pirates, epitomise the human fascination with gold, the question remains, should young investors invest in gold?

Before joining the gold rush, Mr Goh suggests that young investors weigh their liquidity needs, risk appetite, and investment time horizon. Depending on their individual conclusions, strategic portfolio allocation can range from 10 to a maximum of 15 per cent.

'Physical gold, ETFs, gold mining companies, and gold futures have different characteristics that cater to the needs of both investors and speculators,' he says. 'Hence, it is of vital importance for investors to determine whether they are gold investors or speculators so as to adopt the relevant investment products.'

For gold investors with a longer investment time horizon for instance, investment strategies such as dollar cost averaging and value cost averaging are two relevant and viable investment strategies that should be coupled with relevant fundamental analysis.

The rationale, says Mr Goh, is to take advantage of any price corrections and purchase more units of gold investment for position and enhance returns from the investment accordingly when gold prices rebound.

However, investors should remain disciplined and adhere closely to their respective strategic portfolio allocation by engaging in routine portfolio re-balancing of their investment asset classes.

Investors should also understand the risks, mechanisms, functionality, features, fees, and liquidity of the various gold investment products available before investing, says Mr Goh.

Finally, analyse and look out for changes in the macroeconomic situation, by paying special attention to international economic indicators - inflation, interest rates, energy prices, currency movements, annual global gold supply versus demand - that may have an impact on gold prices.

The recent economist article claims gold investment is another tulip..

The wacky world of gold
Why gold bugs no longer love gold miners
Jun 2nd 2011

STRIKING gold is generally considered a slice of good luck. Owning it, however, is a sign that you fear the worst. Some people buy the yellow stuff because they think it looks pretty, to be sure. But the quintessential gold bug is an investor who expects every form of paper wealth to collapse, along with civilisation itself.

Gold is not like other commodities. The demand for iron ore depends on down-to-earth things, such as how many steel girders Chinese builders are using. The demand for gold depends on airier considerations, such as whether you think Barack Obama is the Anti-Christ.

Not all gold investors stockpile guns and tinned food in remote cabins, of course. Nor are they all fans of Glenn Beck, an American pundit who preaches doom and urges his listeners to buy gold. But most agree that the world is a scary place. The euro zone is tottering, America’s deficit is alarming and inflation is looming, they reckon. Such fears have ramped the price of gold up to an incredible $1,545 a troy ounce, up almost sixfold in a decade.

Yet gold miners’ shares have failed to keep pace (see chart). This is new. Gold and gold-mining shares used to rise and fall in lockstep. Over the past five years, however, the price of gold has trebled while the value of gold miners has merely doubled. Investors in firms that shift, crush and process rocks are more grounded, it seems, than those who invest in bullion.

As mines age, extracting gold gets harder and costlier. Ores give up less of the metal—average grades have fallen by 30% since 1999 according to GFMS, a consultancy. And ore must be hauled up from ever greater depths. Fuel is pricier. So, too, are labour and equipment, since the global minerals boom has driven up demand for miners and drills. A decade ago the average cost of extracting an ounce of gold from the ground stood at a little over $200. In 2010 it hit $857, says GFMS—though this figure depends in part on the gold price. When gold was $200 an ounce, nuggets that cost $800 to extract stayed buried.

Finding new seams to replace depleted ones is becoming harder. Metals Economics Group, a mining consultancy, estimates that in 2002 gold miners spent $500m on exploration. By 2008 they were spending $3 billion but finding much less. All the easy gold has been mined already.

The big gold-mining firms have turned to acquisitions to boost their reserves. Last year Australia’s Newcrest bought an Aussie rival, Lihir Gold, for $8.7 billion. By value, 31% of the mining deals last year involved gold, according to the consulting arm of PwC. Merged firms seek to cut costs, and often end up spending less on exploration than they did separately. That makes it even less likely that they will find much more gold.

The world’s miners dug up 2,689 tonnes of gold last year. Granted, that was a record. But, despite the huge surge in investment, it was only a few flakes more than the total output a decade ago.

Investing in gold miners carries risks unrelated to the price of the metal. Mergers can flop. As readily recoverable reserves dwindle in stable places such as North America and Australia, miners are forced to operate in more troublesome ones, such as Latin America and Africa. Huge investments can yield disappointing returns if promising mines turn out to contain less glitter than predicted.

Gold bugs, by definition, bet that the price of gold will go up and up. Miners sometimes do the opposite. Many hedged their wares, selling gold forward to ensure smooth cash flows and to raise money to dig more mines. This may have seemed prudent at the time. But it repelled gold bugs and, as the gold price rose ever higher, it hurt the miners’ profits, too. Barrick Gold, the world’s biggest gold miner, and AngloGold Ashanti, the third-largest, have both spent billions unwinding hedges over the past couple of years.

Gold bugs are often allergic to other metals. Gold miners are not. Many produce copper, too, since it often sits in the same ore bodies as gold. In April Barrick offered $7.7 billion to trump a Chinese bid for Equinox, an Australian copper miner. The heavy demand in China and short global supply for “red gold” makes Barrick’s move look sensible. But gold bugs hated it. Barrick’s shares fell sharply after the bid was revealed.

Most damaging of all for the marriage between gold bugs and gold miners has been the arrival of a seductive new financial tool. Exchange-traded funds (ETFs), backed by physical gold, offer investors direct exposure to the gold price without any exposure to gold miners themselves. They have become popular: in less than a decade gold ETFs have gone from nothing to holding some 2,200 tonnes of gold—nearly a whole year’s production.

If the world goes to hell, gold bugs will say: “I told you so.” But if investors ever wake up and notice that the yellow metal is little more useful than tulips, the gold bugs will be burned. The miners, less so
There's just something inherently wrong about bidding up the price of something that provides so little improvement to society.

Imagine all the monies spent on getting difficult-to-extract gold going instead to something like research on improving crop yields or cheaper, cleaner energy.
(13-06-2011, 02:09 PM)kazukirai Wrote: [ -> ]There's just something inherently wrong about bidding up the price of something that provides so little improvement to society.

Imagine all the monies spent on getting difficult-to-extract gold going instead to something like research on improving crop yields or cheaper, cleaner energy.

Haha I agree with you 100%, but try telling that to the Gold Bugs.... Tongue
Ah the point of gold Investment/speculation is the point of not trusting the governments to handle their spending properly, understanding the cracks of the fiat money system as well as taking advantage of the tragedies happening in the world (wars, libya etc) which sees a safe haven move to gold.

Gold will ultimately end up like the bubble and evolve into the greater fool's game, but as said, is a good opportunity to make money as long as you don't overstay your welcome.