Gold: Risky asset class with little use

Gold: Risky asset class with little use

2012-04-15 14:03

Johannesburg – Gold is a good example of an unproductive asset class that produces no income and whose yield is merely dependent on price movements and the moods of investors.

The only way to make money from an investment in gold is to sell it to someone who is prepared to pay more for it than you did.

This means that an investment in gold is far riskier than one in gold shares, says Takura Mahwehwe, portfolio construction analyst at Cannon Asset Management.

Nevertheless, in recent years many have apparently been prepared to pay sky high prices for the yellow metal.

The sharp increases in the gold price over the past 10 years – from $300 a fine ounce to the current $1 600-odd a fine ounce – make the gold bulls appear to be exceptionally smart investors, although they are only gambling on other investors’ view that gold will continue to improve.

Mahwehwe says this means gold is a speculative investment that is even more volatile than an investment in shares. In addition, gold’s usefulness is limited compared to that of other resources.

“Once it has been extracted from the ground, it waits above ground to be sold.”

Gold sales are driven by two main factors: its status as a safe haven in times of uncertainty and as an asset that will retain its value in periods of high inflation.

At the moment there is no lack of news regarding uncertainty in the global economy, and there are fears that the US fiscal expansion programme will be inflationary.

These fears, according to the GFMS analysis group, could contribute to the gold price again reaching a high of $1 900 before the end of the year after a brief slump to below $1 550/oz.

Philip Klapwijk, head of analytical services at GFMS, reckons a rise to $2 000/oz before even year-end is a strong possibility, but is more likely in the first half of next year.

Klapwijk says the rise will be driven by renewed “acute fears” about European countries’ sovereign debt and further (inflationary) fiscal measures in the US as the economy starts to wobble.

Low or negative interest rates and shaky equity markets will neutralise the cost of an investment in gold (as a safe haven or insurance), he says.

Mahwehwe says that it’s precisely the cost of investing in gold that means it's an investment that yields a negative return and, owing to its speculative nature, delivers a much poorer return than other asset classes over long periods.

In fact, the gold price trended downwards for a period of 20 years from the late 1970s to 2001.

There is the further risk that the gold price could rapidly collapse should investors’ views on gold change.

Mahwehwe says that, unlike other investments, no appropriate value can be determined for gold.

“A fair value for assets is largely determined by the income or returns they deliver and gold does not offer either of these. It's therefore difficult to determine whether an investment at a particular price is a good investment.

“Not even the demand for gold can be used to arrive at a value because its industrial use is limited and it is subject to the whims of investors,” he says.

Mahwehwe says an alternative to an investment in gold is one in gold shares, whose value can be determined. A number of factors have caused returns on South African gold shares over the past five years to underperform the rise in the gold price.

The advantage of an investment in gold shares is however that that the yield is modest and dividends in time will add more to the total yield than an increase in the capital.

One ounce is always one ounce – Buffett

American investment guru Warren Buffett reckons gold falls in the investment category of assets “that will never show a return”.

In a February letter to Berkshire Hathaway shareholders this year he said that gold is bought by someone who hopes that someone else – who is also aware that the asset will never produce anything – will in future pay more for it.

This type of investment requires a growing pool of buyers who believe that the pool will continue to grow because others will desire it more in future.

He says gold is currently popular among people who are afraid of every other asset class, but it has two big shortcomings. It has little use or productive power.

Admittedly, gold has some use as decoration or in industrial applications, but both are limited and will not necessarily be able to absorb additional production.

As a result, if you own one ounce of gold for a long time you will ultimately still own one ounce of gold.

Most buyers of gold are motivated by a belief that the number of fearful people will continue to grow. This has indeed been so in the past decade and the rising price has attracted more buyers.

In February the value of the world’s 170 tonnes of gold (at $1 750/oz) was $9 600bn.

The value of the gold being produced each year is $160bn and buyers – jewellers, industrialists, scared investors and speculators – will have to continue to absorb the additional production just to maintain the balance in the market at current prices, says Buffett.

 - Sake24

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  • TheSilverJournal - 2012-04-15 18:51

    Buffet also said "bonds should come with a warning label." So where are people supposed to put there money then when the bond bubble bursts, causing the US to default and the dollar to become worthless?

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