Feature Articles

For more information on investing in bullion, check out our feature articles below.......

Metals Choices – Peter Freeman looks at gold and other precious metals. Money Magazine July 2009

There has been a surge of interest in buying physical gold both as a way of taking out protection against today’s financial uncertainty and of profiting from a possible further surge in the price of bullion.

While gold’s appeal waxes and wanes- its price surged in 2006 and 2007, dipped in late 2008 and then reignited early this year – most investors traditionally have taken their portfolio’s exposure to the yellow metal by buying shares in stock exchange-listed gold producers.

Others invest in exchange-traded funds, such as the Australian Securities Exchange-listed GOLD fund, gold warrants such as Perth Mint’s Quoted Product (ASX code ZAUWBA), unlisted gold funds (examples are Blackrock International Gold Fund and Select Gold Fund) and, for the more adventurous, contracts for difference over gold.

But while all these investments have their strengths, none provides the same psychological and tangible security as physical gold.

“Some gold investors put so much emphasis on security that they don’t even want us to store it for them, even though our storage, and insurance are both provided free” says Robert Jamieson, general manager of Melbourne-based bullion distributor GoldSilverBullion (www.goldsilverbullion.com.au).

While he believes this is an overly cautious approach, he nevertheless understands the desire of investors to minimise what is generally known as counterparty risk. This is the risk that exists when the value of your investment depends on another party- a bank, a fund manager, a bond issuer and so on- meeting its obligations. If it fails, as some major overseas banks have done, your investment can end up being worthless.

Jamieson believes the financial crisis drew attention to this sort of risk and is one of the main reasons why more investors have been buying physical gold rather thank the carious gold securities on offer.

As well as GoldSilverBullion, a range of other gold dealers do business with retail investors. These include Australia’s main supplier of gold bullion, Australian Bullion Company, Ainslie Bullion Company, Gold Bullion Australia and Goldsilverbullion.com.au.

In general, all make their profit from their buy/sell spread, that is the difference between the price at which they buy gold and the price at which they sell it.

Investors interested in physical gold need to check and compare theses spreads. It is also important to check on delivery costs and, where relevant, the cost of storage.

As well, check that the gold you buy is internationally accredited. It should have the hallmark of the gold refinery, such as Australian Bullion Company, stamped on it as well as a stamp of purity.

“Gold and other precious metals should only ever be a part of a diversified portfolio”, says Jamieson.

At the moment, he adds, it seems to be acting partly as a hedge against rising inflation and partly as a bet on a possible further surge in the gold price.

Perhaps the biggest challenge is getting your timing right, since gold’s price history suggests that a significant price boom can be followed by a long downturn.

A study of the real gold price – that is, the price of gold after adjusting for inflation- carried out by the Reserve Bank several years ago highlights this risk.

As the graph shows, after fluctuating greatly, by 2006 the US dollar price of gold in real terms had hardly risen at all compared with 100 years earlier.

Since the RBA produced this graph, the gold price has surged, slipped, and then surged again. A rough calculation suggests that would leave the real price closer to the peak of the early 1980’s.

“Getting your timing right is very important” says Jamieson, who argues that GoldSilverBullion, which was established by a group of former financial planners, is equipped to provide potential investors with guidance about what and when to buy.

“In the case of precious metals, gold isn’t always the best buy”, he says. “Silver, platinum or palladium can be a better option”.

Gold or Cash... Which is Better to Stash?

During the global market meltdown savvy investors have been flocking to the traditional safe havens of cash and gold to weather the storm and avoid the equity market devastation but which is better?

Both gold and cash have provided exceptional diversification to an investment portfolio during these periods of high volatility. These two asset classes have also effectively acted as a hedge which may have offset any negative movements in ones investor’s portfolio during this periods of turbulence.

Over the past 12 months however, gold has outperformed cash with gold producing a stronger return of 22.64% for the 1 year in Australian dollars, compared to a 4.5% return for the year for cash.

As investors stockpile their holdings of gold globally, this has created unprecedented demand for this commodity. The World Gold Council has recently released figures that investor demand for physical gold bullion is up 121%. This huge increase in demand has consequently placed enormous pressures on gold refineries to keep up. Bernhard Schnellmann the director of Swiss refinery “Argor-Heraeus”, and one of the 3rd largest refineries in the world, recently reported that he has never experienced anything like this in the past 30 years.

So needless to say in this time of market chaos, there are certainly emerging exciting opportunities for investment, but when deciding to hold cash or gold there are a number of important considerations - particularly in this complex market environment.

For example, if you are evaluating a cash-based investment, it is especially important to consider the rates of inflation and the effects that this will have on the purchasing power of this capital. If the pace of inflation is higher than the interest rate, the capital base or purchasing power of these dollars will start to deteriorate.

Presently the inflation rate in Australia is running at 5% and in the US the inflation rate is running at 1.1%. This is compared to the reserve bank cash rate is 4.25% and in the US at 0.25%.

So for cash focused investors this would mean that they would require at least 5% p.a. return on your capital to ensure that it keeps pace with inflation, before taxation is taken into account. However if an investor was on a 30% marginal tax rate they would be required to earn at least 7% plus return, just to keep pace of inflation, otherwise their capital would be eroded by the increase in the cost of living. This may however be a very tall order in this market as we have seen interest rates continued to slide downwards.

Gold however over time has managed to keep pace with inflation. In fact back in 2002 oil was valued in US dollars at an average price of $22.81 and gold at that time was valued at $310 per ounce. 6 years later oil average price in US dollars per barrel is $91.48 (before recently dropping substantially) and gold’s average price is $872 US. This represents an appreciation in prices of oil by on average 50% p.a. and gold has appreciated by an average 30% p.a.

Therefore if you had “stashed your cash” back in 2002 you would now be paying substantially more to buy this asset, due to a depreciation of purchasing power. As gold has historically always managed to maintain it’s purchasing power over time, if you had “stashed your gold” instead, you would have kept up with the purchasing power, particularly since the price of oil has dropped substantially. So gold therefore is the better alternative to stash – especially in this current economic climate with the future of the economy looking more and more grim.

Whilst many are comfortable storing their cash with banks in term deposits etc, many don’t know where to start when it comes to storing their gold and think it all sounds too complicated. But the truth is it couldn’t be simpler. When you purchase your bullion from retailers such as GoldSilverBullion, you may have the option to receive a Certificate of Storage whereby the retailer stores it on your behalf. Alternatively you may like to take delivery yourself and store it in a high security vault in your capital city. I wouldn’t recommend storing it under your bed though!

So in summary, when compared to cash in this current market gold is proving to be the better alternative asset class to stash, retain your purchasing power and receive good capital growth. Furthermore, storing your bullions couldn’t be safer as the security measures these high security vaults go to look like something out of the Bourne Identity!

Golden Ratio’s - How the Dow Jones Index can tell you when its time to buy gold.

Historically we have seen bubbles occurring in most investment asset classes such as shares, property and even gold bullion. The bubbles occur as the hysteria builds during the period of appreciation and investors flock to the fast appreciating asset class. The bubble belief is based on the premises that the good times will continue forever and the asset will continue to rise forever.

Throughout time we have witnessed some of the most amazing price appreciations in each one of the key asset classes. Whether it be property boom in Japan whereby the land around the Emperial palace was valued more than the state of California, to the tech boom of the late 90’s when a company with no assets or income could be valued at hundreds of millions, or even the gold boom of the mid 70’s when prices went from $100 to $870 over a very short space in time. The savvy investors always seem to know when to get out, well before the bubble pops and assets prices depreciate suddenly but not everyone is that lucky.

As such, to help us all know when to get out of these bubbles, there are basic ratios which one might utilise to determine if the asset classes which they are considering might be over or undervalued. For example if we were looking at a residential property in Australia where the rental yield was only 1% you might say the asset class is overvalued, yet if it is 4% it may be fair value, and 6% undervalued. For shares you may look at the price earnings ratio and compare this to the index. If it is 30 times you may think the shares are expensive, if it is 11 times you may think it is fair value and 6 times undervalue.

Gold too has its own ratios, but more importantly it can also be used as a benchmark to value a range of other asset classes to determine if they are also over or under valued. To do this you will need to look at the spot gold price valued in US dollars which is presently trading at around $950 per ounce. Broadly speaking, if you multiply this by 6 to 7 times equating to 6,650, and the if Dow Jones index is trading at around this level, then it would be fair to say the Dow Jones Index is fair value. If you multiply the per ounce figure by 10 times equating to 9,500 and the Dow Jones Index is above this level, you would say that the share market index is overvalued. Lastly if you multiply the per ounce figure again by 4 times to 3,800 you would state the Dow Jones Index is undervalue.

So to demonstrate how this ratio works over time, let’s compare this ratio in points of time. At the peak of the market in November 2008 the Dow Jones was sitting over 14,000 whilst gold was only $740 per ounce, equating to more than 19 times the price of gold. In 1929 the Dow Jones stood at 381.2 and gold was 19.06 ounces again this was 20 times the price of gold. In both these instances it would be fair to say these share markets were overvalued.

At the low of 1932 when the Dow was 41.20, gold was sitting at $20 per ounce equating a 2 times multiple. In 1987, we saw the Dow Jones crash to 1739 and gold was priced at $499 which is 3.4 multiple. In both these instances you would say the Dow Jones was undervalued.

By using these basic ratios’s it can help you determine whether or not the share market or gold are overvalued or undervalued. In reality you will notice that the market won’t stop once it becomes fundamentally overpriced or underpriced. In the above examples the market kept roaring past 10 times to levels as extreme as 20 times. The same is true on the downside whereby markets crashed well below the 4 times criteria to as low as 2 and 1 times.

Well renown US financial planner Peter Schiff who forecasted this global melt down we are now experiencing, has also predicted that the Dow Jones will go 1 to 1 with the price of gold meaning that next year the Dow will be 4,000 and the price of gold will be 4,000. Only time will tell, but fundamentally the price of gold is still very cheap and the future growth in this asset classes is very exciting making it an opportune time to buy and include this asset class in your investment portfolio.