GOLD should be treated with caution as price soars

If you had put your money in gold at its lows about a decade ago, you would have made more than a 400 per cent return today.

But with the bullion now trading at record levels, the question is whether buying gold is still a good investment idea.

Gold bugs say the precious metal is poised to move much higher. Gold is attractive, they argue, because it works both in fire and ice types of scenarios.

In the first situation, gold is seen as a good store of value to be held in defence against inflation. If the United States Federal Reserve continues to print money faster than you can read this, this will lead to inflation.

Gold is also said to act as a hedge against the falling value of the US dollar.

Whether this supposition is overstated is debatable. History has shown that since 1988, the correlation between gold and US inflation expectations is just 36 per cent, according to Goldman Sachs.

This means the price of gold rises and falls with inflation expectations just 36 per cent of the time.

Consider the other scenario – gold as the ultimate insurance policy against financial market uncertainty. This argument appears more convincing. Over the last decade, as the global economy stumbled, demand for gold surged. For example, in the second quarter of this year, economic indicators were down and gold demand was up nearly 40 per cent.

Gold has also benefited from strong jewellery demand from China and India, reduced net central bank gold sales, and growing appetite for gold exchange-traded funds, which make it easy for individuals to invest in gold.

Still, the bullion itself is not easily valued, unlike stocks where you can examine the company’s earnings and payout ratios. Gold also has no cash flow and has a negative cost of carry – this means it costs you money to hold it.

Analysts have argued in the last few months that gold will touch US$2,000 (S$2,585) or US$3,000, or even higher in the coming years. Channel Islands-based founder James Turk tips gold to rise to US$8,000 by 2013. Gold hit a record high of US$1,387.10 an ounce last Thursday.

If you look at history, gold’s last bull run quickly came to an end once its price began to rise steeply.

Gold’s spike above US$800 lasted only a couple of days in January 1980, and then by the end of the year, it had fallen precariously to less than US$600.

This was followed by 20 years of mostly falling prices, with gold languishing at US$250 by August 1999.

What took the air out of the last gold bull market was action by then Fed chairman Paul Volcker to raise interest rates into the high teens to tame double-digit inflation.

Investors then switched to stocks and bonds as gold became an unattractive investment. With sky-high inflation being tamed, gold, a hedge against inflation, was now seen as an anachronistic relic.

In 1999, European central banks collectively decided to create a formal and transparent framework for gold sales. They pledged not to enter the gold market as sellers, except for already-decided sales, and agreed that ‘gold will remain an important element of global monetary reserves’.

This was a psychological boost to investors, who became more confident about buying gold near its multi-decade lows.

Gold’s surge has been nothing short of spectacular this year, but the pace at which it has been rising is making me more and more uncomfortable.

Take the last two weeks of last month. Records were broken at breakneck speed, with gold hitting new highs not just once but at least 10 times during that period.

Behind its rise has been the abundance of global liquidity and the Fed’s relaxed monetary policy and weaker greenback.

If you believe the charts, gold is nowhere near a bubble top yet.

I compared the price of gold over the last nine years with the first nine years of the Nasdaq technology bubble of the 1990s and the US housing bubble that peaked in 2006 (using the Dow Jones index of home-building stocks).

Gold’s trajectory looks eerily similar as the previous two bubbles’. But what stands out is that the gold chart, when stacked against the other two, shows that the precious metal is still quite a distance away from implosion.

It is easy to be caught up in the bullish forecasts by analysts, but here is my personal view – I am not in favour of pouring big money into gold when it is at its all-time high. Indeed, for every James Turk out there, I can cite you a bear.

Citigroup bullion analyst Alan Heap said earlier this year that gold prices could sink to US$820 an ounce by 2014.

And Mr George Soros, arguably one of the world’s greatest speculators, warned last month: ‘I called gold the ultimate bubble, which means it may go higher. But it’s certainly not safe and it’s not going to last forever.’

The steep gold price increases have prompted my wife and me to sell some of our gold to take gains.

I might buy gold if the price dips, but if the yellow metal continues to climb the ladder into record territory so rapidly, we will tread with caution.

For those who want to buy gold, remember the importance of portfolio diversification and not to put all your eggs in one basket.

Investment experts tell me that in a balanced portfolio, they are recommending a 2per cent to 3per cent weighting to gold.

Balanced portfolios tend to divide assets between investment-grade bonds and stocks in leading corporations.

Source: Straits Times (subscribers only)

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