About a year ago at this time it was impossible to turn on the TV or pick up a newspaper without encountering something on gold. The asset’s price was soaring, hitting $1,900 an ounce in September 2011 and gold bugs were predicting that the yellow metal would continue to climb. Today, it seems as though much of the rhetoric has died down, probably because the price has moved sideways for the last 12 months. Today, gold is selling for around $1,750.
Just because it may not be breaking new price records doesn’t mean you shouldn’t own any gold. Historically, gold has been a great hedge against both inflation and poor economic performance. With continued deficit problems in Europe and the U.S. and a threat of a Chinese slowdown, it’s possible gold will rise again, says Stephen Lingard managing director of Franklin Templeton Multi-Asset Strategies. “Gold is a great hedge in this environment and that’s why we’ve seen such strong performance over the last few years,” he says.
Since 2008, gold prices have climbed about 100%, while the S&P/TSX Composite Index is almost flat. While both asset classes did fall in 2008, gold will outperform when people are worried about the markets. But Lingard cautions investors about owning gold simply for the returns. Gold prices are affected by sentiment rather than just supply and demand fundamentals, which is what determines the price of most commodities. As soon as that sentiment turns and people feel better about the economy, the price of gold will fall.
“Gold is not a good investment on a standalone basis,” he says. “Equities make far more sense on a long-term basis. What gold does is provide a little bit of insurance and it helps with overall diversification.”
Jamie Carrasco, an investment advisor with Macquarie Private Wealth, treats gold as cash. He’d rather put the cash portion of his portfolio in the metal than the U.S. dollar, which is getting debased thanks to the Federal Reserve’s quantitative easing program (it’s buying government bonds to keep fixed-income interest rates low and help stimulate the economy). “In an environment where paper is getting devalued, it makes a lot of sense to own gold as cash,” Carrasco says. “I’m just protecting my purchasing power.”
He adds that people shouldn’t worry about how high the price will go. “Gold isn’t moving,” he says. “Currencies are declining.”
There are three ways to own gold. You can buy bullion, an ETF or the stock of gold-producing companies. Buying bullion is expensive as there are storage and transportation fees over and above the price of the actual gold, plus fees if you need to turn around and sell your bars, bricks or ounces. Instead, investors have been purchasing gold ETFs at a fraction of the cost of a gold bar. iShares’ Gold Trust ETF, for instance, is trading at about $17, while SPDR Gold Trust, the most popular gold ETF, is selling for $168.
Lingard has about 3% of his portfolio’s assets in the iShares ETF. He likes it because it’s backed by gold. If he wanted to, he could trade it in for some physical bullion and every time new shares are issued, iShares buys more gold. “Make sure that the ETF you buy is backed by the metal,” he advises.
These days, investors may be better off buying gold companies. Stocks have lagged behind gold prices significantly. Over the last five years the S&P/TSX Global Gold Index, an index that tracks worldwide gold securities, is up just 1.36%, while the price of gold has climbed 120%. Historically, gold and gold stocks are correlated about 75% of the time.
The reason for the discrepancy, says Lingard, is that gold companies have things like management, expenses and earnings to worry about, while a gold bar is just a gold bar. “In the past year you’ve had earnings problems and cost overruns,” says the fund manager, explaining why gold shares have lagged.
Because of these issues, gold stocks are incredibly cheap, with many companies trading below 10 times earnings. Carrasco has sold most of his bullion and purchased both gold and silver companies instead. He says that many of companies are basing earnings projections on conservative gold prices, so if the price of gold rises, and he thinks it will, then these businesses should see earnings jump. “Producers are making a lot of money right now and they’re increasing dividends,” he says. “With multiples like this, it’s a gift.”
Lingard also thinks stock prices and valuations will climb. But make sure you’re buying a company that can produce gold cheaply. “If the gold it’s pulling out of the ground is worth more than increases in inflation, wages and production, then in theory they’ll do better as gold prices rise,” he says. “It’s the earnings of the company that are driving these stocks, and not some claim on the physical asset.” Investors who want exposure to stocks can either buy individual securities, ETFs that track the gold sector or mutual funds that hold a basket of precious metal companies.
Once you decide what you want to own, you need to figure out how much of your money should be in this asset class. Since it’s a hedge, you don’t want to be too overexposed to the commodity. Lingard suggests not putting more than 10% in the metal. Carrasco is more generous with his allocation and many of his clients have a 20% to 25% weighting in gold. Other experts suggest putting no more than 5% of assets precious metals.
Either way, with economic volatility continuing into 2013, investors should probably own at least a little bit of the yellow metal. “It’s the right time for gold,” says Carrasco.