All that glitters is not gold

Recently, many big investors such as hedge funds have opted not to invest in profitable companies with expanding businesses, which could have reaped them some handsome dividends.

Instead, they have chosen to keep the bulk of their assets in a somewhat anachronistic investment, hardly in keeping with modern times – gold.

Their new-found enthusiasm for the precious metal has been triggered by a lack of confidence in paper money.

They have been spooked by the unconventional means used by major central banks such as the US Federal Reserve, which unveiled a plan last month to print US$600 billion (S$785 billion) to try to revive the sick United States economy.

This raises fears the US dollar will continue to slide in value.

They have also been unnerved by the unfolding sovereign debt crisis in Europe, where small European countries such as Greece and Ireland have suffered great hardship servicing public sector debt.

One reason gold is so appealing is that no one can magically conjure up any more of the stuff than already is available in the form of gold bars or jewellery, or remains in the ground to be mined.

Indeed, the production of gold has been falling steadily since hitting a peak of 2,645 tonnes in 2001. Last year, the combined output from the top four gold producing countries – South Africa, the United States, Canada and Australia – reached only 756 tonnes.

Gold producers have to turn to harvesting gold scrap from owners of old jewellery cashing in on the high gold prices in order to satisfy the surge in demand.

Looking ahead, market strategists believe that low US interest rates will continue to underpin the rally in gold.

Investment bank Goldman Sachs believes gold will climb to US$1,690 an ounce by the end of next year from its current level of US$1,390.

It expects gold to peak at US$1,750 in 2012, as the US economic recovery gathers pace and causes interest rates to rise.

Another factor inspiring the greater interest: It has also become easier for investors to hold gold.

Past objections such as the inability of the precious metal to provide any income hardly matters any more, given the scant returns which a saver gets from keeping his money in the bank.

There is also no need to hold gold physically. Investors have piled into the precious metal via a financial instrument known as an exchange traded fund (ETF), which enables them to trade gold like a stock.

The largest gold ETF – SPDR gold shares – holds more gold than most central banks, and is worth about US$58 billion. It was conceived originally to allow investors to diversify their portfolios away from stocks and bonds.

However, SPDR gold is increasingly being used in a big way by hedge fund managers to bet against central banks’ willingness to preserve paper money’s value.

Top US hedge fund managers such as Mr David Einhorn and Mr John Paulson have bought gold in huge quantities using ETFs. They have also priced some of the shares in their funds based on the value of gold.

As Mr Einhorn observed in a newsletter to investors: ‘Our instinct is that gold will do well either way: Deflation will lead to further steps to debase the currency, while inflation speaks for itself.

‘The size of the Fed’s balance sheet is exploding, and the currency is being debased. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed.’

Still, despite the many attractions which gold now holds for investors, billionaire George Soros had described the precious metal as the ‘ultimate bubble’, even though his funds were invested heavily in gold and gold-mining firms.

‘It is certainly not safe, and it is not going to last forever,’ he was quoted as telling participants at the World Economic Forum in Davos, Switzerland, in January.

For many traders, the trigger for the huge rally in gold prices is a fear the weakening greenback may stir up inflationary pressure and propel a big jump in prices of commodities like crude oil.

In the long run, however, inflation is politically unacceptable, given the desire by consumers and companies to have steady prices, and this might dampen the demand for gold.

Those with long memories will recall that a similar prolonged rally in gold prices at the end of 1970s was killed off when the Fed, then led by Mr Paul Volcker, decided to tackle inflation that was then rampant in the global economy with a grim determination.

Mr Volcker’s success in taming inflation led to gold slumping to only US$250 an ounce by 1990 – one decade after hitting a then all-time-high price of US$850 in February 1980.

Gold’s huge decline in popularity during that period coincided with the longest peace-time rally in global stock markets in modern history, as companies’ businesses expanded and their profits soared.

Between 1980 and 1990, the US bellwether market gauge – the Dow Jones Industrial Average – soared 228 per cent.

Thus, it is not surprising that, despite its allure to hedge fund managers, some long-term investors feel gold is not really worth holding, given its roller-coaster price in the past 30 years.

They also note that for all its glitter, there are, of course, few end uses of gold to make it worthwhile holding as an investment with intrinsic value.

As legendary investment guru Warren Buffett observed recently in a Fortune magazine interview, one can take all the gold in the world that had ever been mined, and it would fill a cube about 22m in each direction.

‘For what that is worth at current gold prices, you could buy all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have US$1 trillion of walking-around money. Which would you take? Which is going to produce more value?’ he asked rhetorically.

To Mr Buffett, the choice for a investor looking to grow his nest egg is clear – equities, rather than gold, which has little real economic value.

Source: Straits Times (subscribers only)

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