Commercial review: Gold

Those arguing against an investment in gold often point out that the precious metal pays no dividend, produces nothing and is worth precisely what the market will pay for it at any point in time. This last point means, unlike an investment in a company, where the management is free to innovate and devise growth strategies, gold just sits in the vault passively obeying the laws of supply and demand.

Moreover, the anti-gold lobby is fond of pointing out that since the price of gold peaked at around $1921 in September 2011, it has been trapped in a three and a half year bear market ("bear markets" are marked by falling prices, "bull markets" by rising prices).

There is no shortage of predictions from the anti-gold squad forecasting that gold will soon drop through the psychological barrier of $1000 an ounce, and keep on heading south from there.

As with much market commentary about prices, this may be right or it may be wrong.

The plain facts are that the price of gold is down at US$34.78 an ounce at the start of the modern era in 1970, hits $900 around February 1980, plunges back to just over $200 an ounce in early 2000 and eleven years and seven months later hit the September 2011 peak of just over $1920.

Interestingly, after falling sharply throughout the course of 2012 and 2013, since October 2013 gold has been trapped in something like a two hundred dollar price range, between the low $1300s and the low $1100s, with the $1200 level being something of a psychological battle ground.

Not surprisingly, therefore, you can find pundits arguing that gold is destined to sink to below $350 an ounce and others who are confident that it will break through the $2000 an ounce barrier "shortly".

The "facts" can be argued both ways, depending on the pundit's philosophy, but neither side has a functioning crystal ball and the future remains as shrouded in mystery as ever.

The problem with all technical chart analysis is that the right side of the graph is blank and awaits the moving finger of time to reveal itself.

If you take the price of gold and plot the price per year as a "candle stick" (candle stick graphs contain more detail than line graphs since they show the opening and closing price for each data point) what jumps out at you is not so much that gold is a reliable store of value, as that it is a speculator's dream instrument.

Buy in 1970, sell just before the peak in '88, buy again in February 2001 and sell in October 2011, and what you have is a massive gain.

The only problem with this speculative fantasy is that experienced traders will tell you that trying to time the market is a mug's game.

Very few get it right. Peaks and troughs in the market make themselves known with the benefit of hindsight.

Most investors continue to hold their positions for some time after the peak has passed, sitting on a growing loss that they hope will turn to a profit.

The deeper their loss, the greater the danger that they will keep on holding their losing position on the grounds that they have now lost too much to get out and have to hang in there in the hope that the price will come back towards them.

That kind of thinking has been the road to ruin for more than one investor in the market, be it in gold or in stocks.

The dangers of speculation are precisely why most wealth advisors ignore the speculative element in holding gold and focus instead on it as an "insurance" against dramatic falls in other asset classes.

Of course, it is not entirely true to say that gold pays no dividends. There are various ways of investing, one of which would be to invest in gold mining stocks.

When gold is in favour and the prices soar, mining stocks tend to outperform the general market, often by eye-popping percentages. Some of these stocks pay dividends.

However, investing in gold mining stocks is one thing, owning physical gold is something very different.

A miner can go bust and its equity value can hit zero.

The price of gold might fall, but if it ever hit zero investors would have a great deal else to worry about since Armageddon would be upon them.

This, again, is why an investment in gold is generally regarded as "banking" a portion of the portfolio in a (more or less) reliable store of value. If everything else starts to fall apart around you, it is certainly a comforting thought to know that at least a portion of your wealth is not going to vanish.

This line of thinking gains momentum when trust in fiat currencies, which is to say, money not backed by anything other than public trust, is damaged by central banks creating massive amounts of currency out of thin air.

As QE continues to unfold it seems at least plausible that demand for gold will grow, and that the fortunes of those holding physical gold can be expected to rise in tandem.

HARD ASSET'S ENDURING QUALITIES

The purchase of physical gold bars as a truly tangible asset is proving a popular investment, reveals Anthony Harrington

ONE of the most basic rules for successful investing is to buy low and sell high. For anyone thinking of adding a physical gold holding to their portfolio it is therefore natural to ask where exactly the price of gold is in the cycle of peaks and troughs that make up the history of gold from the 1970s onwards.

Since 1968, gold has seen a price range between its highs and lows in excess of $1200 an ounce on a couple of occasions.

The problem, however, is that unless you are clairvoyant the only thing one can say of the price is that it has been volatile since the price was freed to float in the 1960s, and looks like it will continue to be so. However, this volatility is a recent phenomenon.

After Sir Isaac Newton, in his role as Master of the Mint, set the price of gold in 1717 at three pounds, seventeen shillings and ten pence, it remained fixed at for the next 200 years. These days, that over pricing is likely gone for good.

Henceforth it is up to investors to come to their own view of whether the price of gold is going up, down or sideways.

Tony Dobra, a Director at gold bullion specialists Baird and Co points out that while we are currently a long way from the peak of 2011, when gold threatened to break through $2000 an ounce, it is still performing reasonably well when measured in currencies other than the US dollar.

This is an important point since gold is most frequently quoted in dollars.

The US dollar has strengthened markedly since the US Federal Reserve announced that it would be looking to "normalise" interest rates gradually as the US economy improves.

Naturally, as the dollar strengthens, one dollar buys more gold so even if the gold price is stable or rising slightly, if the dollar appreciates faster than gold, it can seem to be falling or static.

Dobra points out that the price of gold in sterling and in euros has been a lot more stable than the dollar price of gold. The precious metal's all time high was 1382 euros per ounce.

We are still 300 or so euros off that price, currently 1084 euros to the ounce.

But back at the beginning of 2014, the price was below 900 euros an ounce, he explains. So investors who came into the market then have done well.

"What we have seen is that demand for gold coins and gold bars has picked up in parallel with the increase in volatility in the gold price.

"Many investors who were using gold ETFs (exchange traded funds) as an easy way of putting some funds into gold are now opting for buying actual physical bars of gold or gold coins," he notes. ETFs are convenient for buying gold or stocks because you simply buy a unit of the fund, which may or may not be backed ultimately by physical gold.

While that creates a very easy entry point for an investor, if you are investing in gold as a serious "survival" insurance, to tide you through a Great Depression style collapse in the market, Dobra argues that it is much more reassuring to know that you have physical gold rather than a piece of paper.

There is another reason for preferring to invest in physical gold. While you can buy a share of a gold ETF for a relatively trivial sum, there is the ETF's annual charge to consider.

"Holding an ETF is about twice as expensive as holding physical bars. An ETF management charge is typically 0.4 per cent to 0.5 per cent of your holding per year. We typically charge 0.2 per cent for storing people's gold bars for them," he says.

Moreover, customers who have their gold stored for them at Baird & Co's site are free to come and inspect their gold holdings at any point, and can remove bars from storage as they see fit.

As Dobra notes, this provides a high level of confidence that the gold is indeed the customer's property.

It is also registered in the customer's name and is not on the books of Baird & Co as an asset.

This means that, if the worst were to happen and Baird was to fail as a company, no liquidator could hold on to the customer's gold.

Investing in physical gold is surprisingly easy. Baird & Co sell bars of five different precious metals, including gold and in all the company does some 80 different bars.

In gold, the options are to purchase bars from 1gm up to 1000 grams.

So, for example, investors have the option of buying 2.5gm bars or any variety of 5gm, 10gm, 20gm, 50gm, 100gm, 250gm, 500gm and 1000gm bars.

They can also buy bars denominated in ounces, which saves having to convert from ounces to grams to reference the holding back to the price of gold. The options given here are 1/4 ounce bars, 1/2 ounce bars, 1 ounce or 5 or 10 ounce bars.

Just for interest's sake, at the time of writing the 2.5gm bar retailed at £75 and is about the size of a thumbnail (14mm x 23mm).

"Our most popular bars are the one ounce and the 50gm bars.

"Generally people buying less than £10,000 worth of gold tend to take it home with them and work out their own storage. We have a minimum cost of storage of £45.00 a quarter, so you really want to have around £50,000 and upwards of gold before storage becomes worthwhile.

"Below that the cost of adding insurance protection for your gold to your own household insurance is the more economically sensible option," he comments.

Overall, Baird & Co shifts in the region of 10 tonnes of gold a year in bars and another couple of tonnes in gold coins. As Dobra explains, the company buys quantities of second hand gold from jewellers and other sources and then refines it in its own refinery.

"We do not speculate in the gold market at all. For every ounce of scrap gold that we buy we sell one ounce in the market, which hedges our exposure to fluctuations in the gold price," he explains.

CENTRAL BANK HOARDING OF GOLD UNDERPINS TRADING PRICE

MANY factors go into determining the moment by moment price of gold. However, if one looks at the big picture, there are two contradictory pressures at work.

On the one hand, there is a downward pressure on prices from excess production, with smaller mining companies continuing to maximise their output despite recent falls in the price of gold. Excess supply inevitably works towards a softening in the price.

On the other hand, China - the world's largest gold producer by far - is hoarding its own production and buying continuously on the global gold market to supplement its stockpile.

At the same time, a number of central banks have also been actively adding gold to their own reserves. This demand from central banks helps to soak up excess production and works to underpin the price of gold.

The World Gold Council (WGC) points out that because gold is virtually indestructible, virtually all the gold that has ever been mined during the course of human history is still around in some shape or form.

In all, the WGC reckons that mankind has mined some 168,300 tonnes. If this was all gathered in one place and cast as a cube, the WGC says, the resulting cube would have sides measuring 20.6 metres.

This would barely be enough to give all 6.8 billion people on the planet around 0.78 ounces per person.

Given the tonnages already collected by central banks, with the US leading the field at holdings of 8,133.5 tonnes and Germany in second place with 3,383 tonnes, and with total world official gold holdings amounting to 31,957.5 tonnes, that leaves a significant tonnage in private hands. Much of this, however, is in the form of jewellery, rather than bullion or gold coins. Jewellery accounts for about 50 per cent of all the gold ever mined.

It is often said that the gold market is tiny by comparison with the $5.3 trillion traded daily in the world's foreign exchange markets.

However, the WGC reckons that it is big enough so that even significant purchases by central banks do not move the price much or impact the overall liquidity of the market.

BIG PLAYERS SUSPECTED OF CAUSING MAJOR FLUCTUATIONS

THERE is a fair amount of evidence, and a good deal of anecdotal commentary, concerning manipulation in the gold market by the larger players.

However, it should be said at the outset that for anyone buying gold as a 5-10 per cent 'insurance' segment of their portfolio, short-term fluctuations in the gold market - whether from legitimate price movements or sleight of hand - are irrelevant.

That said, the bases for claims that the gold market is regularly manipulated are many and various.

Among these is the tendency for the odd massive sell order to come in when the market is at its quietest, with the fewest participants. At such periods, liquidity in the market thins out and it does not take that hefty an order to move the price significantly.

The suspicion is that when this happens, a big player - such as a bullion bank - has waded in, dumped a pile of gold on the market, crashing the price, then buying it all back at a significantly lower level, cleaning up a nice profit in the interim. The wheeze works just as well with price rises - buy a sudden, significant amount to drive the price up then sell even more at the inflated price.

Why is this bad? Because the perpetrator's profit is at the expense of a host of small retail traders who will have set stops on their positions to make sure they don't get completely wiped out if the market crashes.

A big order dump triggers all these stops, creating losses for those involved. Plus, since the sale has blatantly been simply in order to push the market price down, it counts as manipulation - and this is not just frowned on, it is illegal.

However, and this is an ongoing gripe from investors, one never sees the regulatory authorities pursuing or investigating these trades - possibly because they know that the perpetrator will simply spin a plausible story around the offending trade.

On a different note, the Toronto-based asset manager Eric Sprott points out that if you take 2013, gold price movements through the year were a real puzzle. "The price of gold and silver declined by a significant amount while demand for physical bullion from emerging markets and their Central Banks was exceptionally strong," Sprott says.

However, none of this matters to a buy and hold investor in physical gold since it all evens out over time - or so the theory goes.