Thursday, September 29, 2011

The lure of gold - Strictly for the brave

Here’s an interesting article I thought would be worth sharing:
The lure of gold - Strictly for the brave
By Henri Aram
Gold has excited the imagination of people all over the world for thousands of years and has exerted an influence on world affairs not matched by any other metal. The passions it arouses today are like those of centuries past.
Gold is a highly portable crisis commodity. It thrives on political upheavals and currency uncertainties. Lately it is joined by another travel companion the oil crisis. For as long as people distrust their paper currencies or fear the necessity of a hurried exit from their homestead, the mystique of gold is likely to remain.
But gold costs money to keep and earns the owner nothing while held. This must be remembered when considering gold as an investment. Australians are fortunate in that we do not live in the shadow of those crisis conditions that force many people into gold. We enjoy political stability and a currency backed by the vast wealth of our natural resources, making it stronger than most people recognize.
Up to this point it almost could have been written earlier this year, however this article was actually published on October 10th 1979, a short 3 months before Gold quickly doubled in price and then just as swiftly fell back entering a 20 year bear market (Gold closed at US$410 on 10th October 1979, rose to a peak of $850 on January 21st 1980, before crashing back to the $400 level 18 months later in mid 1981). The article continues below:
Since 1971, when the US Government ended the convertibility of the US dollar into American-held gold, the price of gold has risen steeply. From around $45 a fine ounce, it exceeded $340 for the first time in September this year. During these years the value of the US dollar has declined.
But the price of gold did not rise constantly or predictably. At times it fell by as much as 30 percent in a matter of weeks before resuming its climb. Herein, lies the risk that must be recognized with gold. With price fluctuations such as this, gold cannot be regarded as the guaranteed inflation hedge that it is often held to be.
The Australian Government in 1976 suspended part of the Banking Act which made it possible for Australians to own gold bullion and an unrestricted amount in gold coins. The investor who wants to place portion of his savings into gold can now do so in a number of different ways.
Gold bullion can be bought from dealers and through agents in bars ranging from 100 grams to 1 kilogram; you will pay the day's ruling price for Gold plus a premium and handling charges. When you sell you will realize an amount calculated by the dealer on the ruling price for gold less buy-back costs and charges. To finish ahead you will have to cover the premium, buying and selling charges.
In addition, the rise in the price of gold would have to compensate you for the loss of interest, after tax, you'd have gained by investing elsewhere.
Gold coins likewise are an investment in gold. You will gain not only from any price rise but also from the enjoyment of collecting something of value and beauty. Their price will be related in part to their gold content but more probably to numismatic (collector) value. A coin of great numismatic interest leaves its gold content value far behind.
The Krugerrand has become a popular coin because of its high gold content. Collectors of this coin have done well as the price of gold rose. The South African Government, which conceived and promoted the Krugerrand, has done even better. The Australian Government now also plans a $100 gold coin and possibly a 1oz gold coin for issue early next year.
Shares in listed gold mining companies offer an alternative to investing directly in gold bullion or gold coins. The share prices will fluctuate, largely in line with the price of gold, but you may gain some return where the company pays a dividend.
Gold futures are strictly for the ultra brave with money earmarked for loss, not for the amateur, the faint-hearted or the conservative investor. You not only stand to lose your initial stake, but you will have to fund a margin of loss where the market turns against you. Where you buy futures in expectation of a price rise for gold, and instead it falls, or you sell futures expecting the price to fall, and instead it rises, you must keep on paying up until you are sold up and have discharged all your obligations under the futures contract.
Gold jewellery makes you a small but happy investor. Of course you would buy estate jewellery with no sales tax, or you'd never get your money back. A beautiful 18-carat gold bracelet to which you can add gold coins as charms would probably cost you little more than its gold content. You will enjoy owning and wearing it and be less disappointed if you make no money on resale. Link
In a follow up article after the precious metals price crash (18th June, 1980) Henri goes on to briefly explain the reasons for the price falls:
If speculation is the fuel for inflation, then inflationary pressures on the economy should subside as the cost of that fuel is made too expensive. The United States Government took just that sort of action some months ago. With gold, silver and commodity prices skyrocketing they imposed an interest rate of 20 percent on bank lending. Almost overnight the prices for gold and silver plummeted, commodity prices fell and the speculators in commodity futures got their fingers burnt.
As a result, however, the US dollar strengthened against other currencies. More and more people switched their investments into US currency in order to take advantage of the higher interest rates on offer. Link
While there are some similarities between the crisis today and that of 30 years ago, the US is in no position to increase interest rates should it need to curb inflation and in fact Bernanke recently acknowledged that the Fed funds rate would likely be kept at lows for another 2 years. That said with consumers paying down debt, banks not lending and the threat of sovereign debt write downs, there seems to be a higher risk of deflation in the short term.

It is yet to be seen whether the Fed, ECB & other Central Bank forces will try and fight this environment full force (further than wordsmithery to try and talk the markets up) with the printing presses, Bernanke recently surprised with his lack of action (beyond Operation Twist) at the September FOMC meeting.

Whether we face deflation or inflation, Gold will in my opinion continue to act as a crisis hedge and rise in price over the medium term regardless of environmental factors (although short term price action can be dictated by events and pressures). Though a
s Henri pointed out 30 years ago and is still relevant today, Gold is not without it's risks and heavy or leveraged exposure should be treated with caution.


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