By MARCEL PORCHERON 12/05/2006
The gold price broke through $700 an ounce this week, its highest level for 25 years. This is a major recovery from just $252 an ounce in July 1999, but still short of its all-time high of $850 an ounce in January 1980 (especially when inflation is taken into account).
| "Gold is one of the few commodities where there is a trend of negative net consumption." |
Gold is quite unique because it is one of the few commodities where there is a trend of negative net consumption, so new supply adds to the global stockpile. Although new supply via mining only increased by 1% during 2005, overall supply rose 15% - largely thanks to central banks selling off reserves. Nonetheless the gold price is proving resilient at present.
Reasons cited for the recent surge in price include mounting tension over Iran’s nuclear programme and speculation that China could quadruple its gold reserves (from 600 to 2,500 tonnes) as a hedge against exchange rate movements. By exchanging some of its Dollars for gold China would effectively be diversifying its portfolio, reducing the impact of Dollar movements on its overall reserves.
The attraction of gold in such circumstances is that it is one of the few financial assets where value does not depend on the financial strength of any one creditor, unlike equities or corporate bonds. Investors therefore view gold as a safe haven at times of financial stress.
| "Jewellery still accounts for the majority of gold demand." |
However, despite the renewed interest in gold for investment purposes, jewellery still accounts for the majority of gold demand. In 2005 jewellery accounted for 73% (2,736 tonnes) of total end-use gold consumption, while identifiable investment stood at 16% (600 tonnes). In turn, India was the largest consumer at 23% of global demand, followed by the Middle East, US and China. Increasing prosperity in both India and China may lead to a further surge in demand (via greater jewellery consumption), although high gold prices in early 2003 actually caused some Indians to sell-off and pocket gains, causing a boom in the gold recycling trade but reducing new gold consumption and hence price.
For investors the two main routes for gold exposure are buying gold bullion and buying shares in gold mining companies. The latter tends to offer a gearing effect on the gold price, so is usually more profitable when the gold price rises but hurts when prices fall.
Buying gold bullion is impractical for most investors as there is often a premium of 15% or more on gold coins and small bars while large gold bars have a high entry cost and you must pay storage charges. With this in mind the introduction of the Gold Bullion Securities Exchange Traded Fund in December 2003 was welcome, as it provides a straightforward route to tracking the gold price.
Funds offer a practical route to investing in gold mining shares and can benefit from managers diversifying into other precious metals to reduce risk.
Gold remains a sensible portfolio diversifier but it’s important to remember that its price can be both cyclical and volatile, so we suggest limiting exposure to around 5% of portfolio value.