Sent: 24-02-2009 16:36:01
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Gold: If Not Now, When?
Gold has seemingly enjoyed the most perfect conditions but absolute returns from physical holdings or gold related equities have been disappointingly weak.
Gold has been accorded special status as an investment asset class. The analytical basis for this is a little flimsy. Why gold and not plywood, for example? Over the nearly 30 years between 1980 and 2007, plywood prices rose at a 1.98% average annual rate compared to a 0.62% rise for gold. The average yield on three month U.S. treasury notes over this same period of time was 5.79% per annum. There is little in the history of relative returns to convince an entirely objective investor of the merits of gold.
The case for gold is rooted in ancient history. Quite simply, it became a more trustworthy store of value than coins minted by governments. But for the occasional gold rush, supplies were limited permitting the wealthy to keep their stranglehold on the financial levers. They could also keep their wealth stored neatly and discreetly. The wealthy remain attracted to this concept.
In the midst of man-made financial disasters when national currencies are at risk, gold is supposed to offer a path to financial security. What greater financial disaster could we imagine than what we have in front of us now? The question for investment returns from gold is "if not now, when?".
However, the value of gold is very much in the eye of the beholder. It has little intrinsic value. If all the world's gold supplies were to suddenly disappear, beyond a few surprised central bankers, there would be little detrimental effect on the world economy. This would not be so if oil or bauxite or even unfashionable lead similarly disappeared. Large parts of the global economy would quickly grind to a halt. Misery would prevail.
In this respect, gold has the characteristics of the fiat currencies it is supposed to supplant. It only has value as long as a buyer and a seller agree to place a price on it. That price could be $1 or $1000. The price is entirely discretionary because virtually all the gold ever produced is still available in stockpiles today. Consequently, the marginal cost of obtaining physical gold, since it is never consumed, is very low and largely unrelated to the cost of mining.
If it were to act as a currency substitute, the gold market would offer extraordinary leverage to changing macroeconomic conditions. The gold market is much smaller than other financial markets so that even modest amounts switched from global equity or foreign exchange markets, for example, could swamp the gold price. The subdued reaction to the macroeconomic convulsions of the past two years signals that gold could have lost a good deal of its investment allure.
There are several reasons why this might be a reasonable conclusion. One is the elimination of international capital market constraints. Capital is now relatively free to roam across national borders and different financial instruments whereas not so long ago local residents in China or Russia, for example, had far fewer alternative stores of value from which to choose than they do today. For them and many others, gold played a role which has lessened considerably as access to a wider array of investments has become possible.
Gold equities should offer still additional leverage. Equities and are one of the easier ways for individual investors to tap the gold market, albeit indirectly. However, while the Australian stock market has fallen by 48.9% since it reached a peak at the end of October 2007, the S&P/ASX All Ordinaries gold mining index has also fallen. A -26.7% return has failed to compensate for losses in other parts of the market posing further questions about the capacity of the sector to act as a hedge against adverse market conditions elsewhere.
A forthcoming edition of the monthly ATC Digest, available for subscription from http://www.atcbiz.com.au/digest.php, discusses some of these issues in more detail. In particular, it discusses whether the muted response of gold prices to changing conditions is a terminal fault and what ongoing connection we can expect between gold prices and equity values.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.