A new way to go for gold

Nov 06 2012 13:37
Finweek - Simona Levet

GOLD has more than doubled in price over the last five years. In part, the surge in gold has been a function of it being a store of value in times of crisis. More recently, gold has benefited from its reputation as insurance against inflation.

If anything, the inflation stars appear to be aligning to drive the yellow metal even higher. Not only has the US committed to quantitative easing on repeat, but the largest economies all appear intent on devaluing their currencies through accommodative monetary policies.

So what’s new? The difference now is that US banks are no longer hoarding vast quantities of cash at the Federal Reserve. This is evidenced by the increase in US broad money growth. In other words, banks are finally providing new loans using the first and second rounds of quantitative easing in the US – nicknamed QE1 and QE2 – never mind the most recent bout of QE3.

This new money filtering into the US economy sets the scene for price inflation. The US consumer price inflation already started to ratchet up in August this year – and the price-accelerating effects of the drought have yet to wholly feed through.

In addition, the huge demand for dollars that helped to mop up some of the supply at the height of the eurozone crisis has faded somewhat as the situation appears to have stabilised.

With trade in physical gold bullion out of bounds, South African investors who want a piece of the precious metal action are confined to either gold mining shares or exchange-traded products (ETPs).

Between mining regulation uncertainties, rising costs, threats of nationalisation and labour strikes – gold mining shares have lost some of their shine. Even though shares offer the benefit of a dividend, ETPs currently appear to be a more attractive proposition.

To the ETP stable, Investec has added a new Exchange-Traded Note – GOLDEN. What sets this new product apart from Absa Capital’s NewGold ETF and Standard Bank’s Gold-Linker ETN, is that it allows investors to invest in the dollar price rather than the rand price of gold.

A so-called Quanto feature provides built-in exchange-rate risk. This means that a percentage move in the gold price equates to a similar percentage move in the note.

“Previously investors had no choice but to hedge out the effects of the rand if they wanted pure gold exposure”, says Brian McMillan of Investec Structured Products. This resulted in additional complexity and cost.

Since an increase in the price of gold has tended to coincide with a strengthening rand, and vice versa, McMillan says that “the problem with investing in the rand price of gold is that it can distort the returns that you earn”.

Using existing products, investors may have made a significant gain in the gold price, only for it to be negated by the rand’s move. “The price of gold is hard enough to predict without having to add the price of the rand into the equation.”

A further defining feature of Investec’s Gold ETN is the cost. The total expense ratio (TER) of NewGold ETF is 0.4%, while the Gold-linker carries a TER of 0.5%. The Investec Gold ETN does not have a management fee, but rather a fee based on the daily Quanto charge. Currently this is a minimal 0.001% per annum.

With an outstanding annualised return of 23.91% since inception to the end of September 2012, NewGold’s top ranking market capitalisation among the ETPs is understandable. However, performance is just one of the factors that should be taken into account when considering an investment strategy.

Another key element in determining the optimal mix of assets within a portfolio is risk. The dollar price of gold has tended to exhibit a lower volatility than the rand price of gold that’s tracked by the existing products.

However, in terms of the products themselves, there is an important distinction an investor should bear in mind.

Whereas NewGold is fully covered by holdings of gold bullion, there is no recourse for ETN holders to the underlying assets, and investors in ETNs are consequently exposed to the credit risk of the issuer.

Source: Bloomberg

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investing  |  commodities  |  gold



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