Keep gold in your portfolio if you want to sleep easy at night, reports Barbara Drury.
The past two years have proved not only that sharemarket busts follow booms as surely as night follows day, but also that reports of the death of gold were premature. The recent rise in the gold price to about $US352, after four years in a trough below $US300, has sparked renewed interest in the metal as a sound investment.
While timing the peaks and troughs of market cycles is a mug's game, the sheer unpredictability of financial markets in recent years has underscored the importance of maintaining a diversified portfolio, and that still includes a smattering of gold.
Research by actuary David Knox of PricewaterhouseCoopers (PwC) found that a small amount of gold in a diversified portfolio acts as a buffer against extreme negative returns from traditional assets. This is because gold returns have little or no correlation to returns from shares, property, bonds or cash.
The effect of gold is different depending on the period examined, but Knox found that the inclusion of gold in a portfolio has little impact on overall returns and significantly reduces volatility. In other words, investors reduce risk and sleep easy at night with little or no reduction in their financial rewards.
For example, in the 10 years to June 2002, including one of the biggest sharemarket booms in history and the subsequent bust, the inclusion of 5 per cent gold bullion in a portfolio would have reduced returns by less than half a percentage point but significantly reduced volatility.
Graham Tuckwell, the chairman of Gold Bullion, which commissioned the PwC research, says that apart from the conservative actuarial reasons for holding gold, there is also a price argument at a time when the outlook for equities, property, bonds and cash is uncertain.
"What do you buy? Gold is like currency but you can't print more of it at will," he says.
Many experts argue that returns from equities are likely to be flat or below average for up to 10 years. This has lead to speculation that hard assets, including gold and other tangible assets such as coal, petroleum, timber and real estate, could provide the best returns for the next decade.
Kerr Nielson, the managing director of Platinum Asset Management, says simply that investors have to have gold in their portfolio at a time when global financial markets are under enormous stress.
"We're not convinced [the current bounce in share prices] won't end in tears," he says. Nielson stresses that his own risk tolerance is high, and that his personal investment strategy (as distinct from Platinum) is not for everyone, but he says he is taking positions in gold price futures "to give myself some pep", as well as some insurance against his high exposure to international equities.
Investors who want the diversification benefits of gold without the "pep" may prefer gold bullion or gold mining shares (see "How GOLD shares pan out" below).
How gold shares pan out
The quickest and easiest way for the average investor to stake their claim to some gold is through the sharemarket. The fall in global equity markets, the weakening US dollar and fears of global terrorism have ignited the gold price and gold shares, although the strengthening Australian dollar has dampened the impact for gold miners whose cost base is in Aussie dollars.
Global consolidation of the gold mining sector (to the point where the top 10 miners control 62 per cent of the West's gold production) has provided further support for the gold price, but reduced the numbers, and quality, of locally listed miners.
A Macquarie Equities resources analyst, Frank van Rooyen, says investors have to be selective because some gold miners have more hedging in place and hence offer less leverage to the gold price. Of the major miners, van Rooyen says Lihir Gold has less hedging than its peers; it is a very liquid stock and its Papua New Guinea gold mine has a US dollar cost base. Even so, he prefers Newcrest Mining among the bigger miners and Kingsgate Consolidated - its major mine is in Thailand - among the mid caps.
Van Rooyen says Newcrest has the strongest organic growth prospects of the local miners. When its new Telfer mine comes online in 18 months, it will boost the company's gold production by 1 million ounces, to 1.7 million ounces a year.
Newcrest's share price has also been supported by takeover speculation, since it is one of the few large targets remaining. Last week Newcrest traded at $7.86 compared with its 12-month low of $5.50.
However, a UBS resource analyst, Shaun Giacomo, says Newcrest may be too expensive to swallow for even the rich North American miners such as Barrack and Newmont, because of its large debt and high levels of hedging. "At the current share price they can afford to be patient," he says.
Giacomo prefers Lihir because it has lower levels of debt, a strong balance sheet, a good asset in PNG and not much hedging.
If the vagaries of the gold mining industry are all too much, the Australian stock Exchange (ASX) recently launched an easier way to gain exposure to physical gold.
Gold Bullion Securities, or GOLD, entitle buyers to one tenth of an ounce of gold bullion at roughly one tenth the spot price for gold converted into Australian dollars.
The underlying gold is held in trust for investors, obviating the need to take delivery of gold bars or coins and then find someone to store and insure it. A small management fee is deducted from the value of GOLD shares each month to cover storage and handling.
GOLD shares can be traded on the ASX but shareholders can take delivery of their gold bullion or sell it for cash if they prefer.
