June 22, 2008

Gold Could Be Prime Alternative Investment

Conal Gregory,

Personal Finance Regional Journalist of the Year, looks at the potential for gold in a portfolio

Gold has a lustre all of its own. Today its appeal goes far beyond the ornamental. Without doubt, it is the traditional commodity to turn to in troubled economic times.

With the markets not going in any coherent direction and few believing the United States Federal Reserve Board Chairman that the mighty American market in now on the up, gold looks just the place for some diversification.

Washington is trying to stimulate its economy by putting $168bn into people's pockets to boost consumer spending, which accounts for two-thirds of its gross domestic product. Yet unemployment there rose in May by the fastest rate for 22 years.

In the UK, Chancellor Alistair Darling gave away Pounds 2.7bn last month - the largest tax cut since the 2001 pre-election budget. Homeowners, often planning that the increased value of their property will fund retirement, are worried: House sales have slumped to a 30-year low and the Council of Mortgage Lenders forecast repossessions will jump by 50 per cent this year to 45,000.

To cap the concern, oil is forecast to reach $150 a barrel within a month, according to investment bank Morgan Stanley.

Gold is used in many ways. Over the past 10 years, the broad diversification has been 77 per cent jewellery, 12 per cent investment and 11 per cent for industrial purposes, according to the World Gold Council.

Some countries already have a tradition of buying gold as a form of personal saving: Both the two economic superpowers of the future - China and India - find this attractive, often holding the gold as jewellery.

The queues that formed in China to buy solid gold rodents at the start of their new year (with the rat as its symbol) should leave no one surprised by the appeal of the metal.

Their governments know that Gordon Brown, when Chancellor, sold half the UK's gold reserve at a disastrous price - around one third of its current value.

Gold has kept its value over the centuries with a purchasing power today not unlike 300 years ago while most paper currencies lost over 98 per cent in the 20th century.

The price of gold - quoted usually in US dollars per troy ounce - declined 1981-1999. From a low of 252.85 in May 1999, it rose to 833.75 last year (a 27 year high) and this March reached 1011.25.

Inflation erodes savings but gold forms a good defence. Retail price inflation is 4.2 per cent but factory-gate prices are up 7.5 per cent.

No wonder the Bank of England Governor has indicated this upward trend will continue.

Investors have been partly compensated by banks and building societies raising interest rates but many savers are rightly worried over the stability of financial providers, following the effective collapse of Northern Rock.

One factor that appears to have been overlooked is the supply problem of gold.

South Africa has been the largest gold producer since 1905 but is unlikely to keep up production owing to a lack of electrical power.

Maintenance on power stations has not been kept up to date and the promised new stations have not been constructed.

In consequence, China is taking South Africa's place as the global gold producer and is likely to up the price to reflect demand.

Gold buying does not have to be the clever preserve of institutional investors, hedge funds and major states. Russia raised its holdings by 44 tonnes last year and now holds 438 tonnes.

Worried by political events in the US, many Asian governments may switch out of dollars into gold. The present price may therefore be a pause before a further upward move.

Remember one downside is that gold does not produce any dividends. It actually generates negative yield as it pays no interest and there is the cost of keeping it physically.

The first and perhaps most obvious way into this market is to purchase coins and small gold bars. Look particularly for the South African krugerrand (22ct gold), US Buffalo (24ct), Canadian Mapleleaf and British sovereigns.

Contact such dealers as ATS Bullion in London (020 7240 4040) and Chard in Blackpool (01253 343081). Take into account insurance, packing and delivery costs (or storage if asking a dealer to hold stock) and the trader's return when selling.

Avoid commemorative coinage which looks appealing but is unlikely to show a good investment return.

Buying shares in gold mining companies is a second method with the benefit that gold stock values increase faster than physical gold prices. However, there is the uncertainty of finding gold and rising expenses (labour, power and equipment).

Consider both Barrick Gold, which mines mainly in Australia and the US, and AIM-listed Leyshon Resources which is starting production in China.

A broader way to gain gold company exposure would be to buy into a fund which holds mining stocks. The four London stock market leaders are:

-- BlackRock Gold & General (formerly Merrill Lynch Gold & General);

-- CF Ruffer Baker Steel Gold;

-- Smith & Williamson Global Gold & Resources;

-- Investec Global Gold

Over the last three years, the first three funds have risen 153, 83 and 132 per cent respectively, according to Lipper research. The fourth is relatively new.

The BlackRock fund has been the UK's most successful unit trust since its launch in April 1988. Pounds 1,000 invested then would now be worth around Pounds 27,000 - a rise of 2,600 per cent by comparison with a 95 per cent increase in the price of bullion over the same period.

Next month Schroders plan to launch a fund (Gold & Metals) investing in 15 to 24 different metals based on the futures market. Luxembourg based, the minimum investment will be Pounds 1,000.

Accounts can be opened based on gold - allocated, which is effectively asking a dealer to hold gold in a safety deposit box, and unallocated, where the dealer can use stock to trade.

The former means specific bars or coins are set aside with a record kept of the hallmark, weight and fineness. Baird is a leading dealer (020 8555 5217).

Exchange traded funds form another way into gold. This is not a collective fund (like those above) but really a tracker which follows the price of gold up and down.

If the idea of holding gold but at a distance appeals, gold certificates are offered by the Perth Mint, which is guaranteed by the government of Western Australia.

It allows savers to hold stock in allocated or unallocated accounts.

This is a low-cost entry to gold with no shipping or insurance fees and minimal expenses. It is offered in the UK by Gold Investments (020 7283 7752) who can also offer unallocated based on Frankfurt.

Gold may have been the plaything of kings and spoil of conquerors but today is the increasing choice of canny savers.

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