There’s more to gold than meets the eye

March 2012

COME Octo­ber, investment-grade gold will effec­tively be 7 per cent cheaper as Sin­ga­pore has decided that it will scrap the goods and ser­vices tax (GST) on the import and sup­ply of pre­cious met­als to encour­age more gold trad­ing here.

What this means is that investors — whether retail traders, gold exchange-traded funds (ETFs), or pri­vate bank­ing clients — will soon be able to trade and store their gold in Sin­ga­pore free of GST.

At the moment, most invest­ments of this sort are done off­shore or kept within the free trade zone at the Sin­ga­pore Freeport.

Before a young investor enthused by this prospect runs out to buy him­self bul­lion gold bars or coins though, here are some issues to consider.

Is gold still a ‘safe-haven’ asset?

Gold has tra­di­tion­ally been seen as a ‘safe-haven’ in times of eco­nomic uncer­tainty and as a hedge against infla­tion. Many still view it as such.

‘Given the on-going euro­zone debt cri­sis and con­cerns regard­ing a slow­down in global eco­nomic growth, gold con­tin­ues to be a safe haven for investors to park their funds,’ says Kelvin Ngo, head of invest­ments at inde­pen­dent finan­cial advi­sory firm Providend.

In the past two weeks, ‘gold prices have come down due to the US show­ing bet­ter eco­nomic and jobs data’, observes Lynette Tan, invest­ment ana­lyst at Phillip Futures.

‘Sim­i­larly, with the Greek debt deal tem­porar­ily resolved, investor appetite could return and gold could be side­lined for now,’ she adds.

With the focus now on eco­nomic growth in China, Europe and the US, if investors begin to feel uncer­tain about sus­tained growth again, ‘safe haven demands’ for gold may return.

But there are those who do not see gold as a safe haven asset. ‘Gold is not like bonds, where there is a reg­u­lar cash flow from inter­est,’ says Wong Sui Jau, gen­eral man­ager of Fundsupermart.com, the online unit trust dis­tri­b­u­tion arm for iFAST Financial.

‘His­tor­i­cally, gold and gold equi­ties have shown fairly high volatil­ity as well. Thus we don’t believe it exhibits the qual­i­ties of a safe haven asset,’ he says. In his view, gold can be an invest­ment to con­sider for diver­si­fi­ca­tion pur­poses, but should not be seen as low risk. ‘Based on three-year annu­alised volatil­ity, gold has almost as high a volatil­ity as equi­ties,’ he says.

How much longer will the gold bull run last?

Gold prices have surged in recent years, which gives investors rea­son to ‘be cau­tious in their invest­ment stance, espe­cially if one is look­ing to make a quick profit’, says Mr Ngo.

But he thinks the bull run could con­tinue as long as global risk aver­sion remains high, real inter­est rates stay neg­a­tive and the out­look for the USD, euro and yen remain neg­a­tive. He sees three main cat­a­lysts today — the euro­zone debt cri­sis is not expected to be solved in the near future, the Fed­eral Reserve has indi­cated that inter­est rates could remain low till 2014, and the print­ing of money is expected to weaken the US, euro and yen. ‘Hence, the gold bull run could eas­ily con­tinue till the end of 2012,’ says Mr Ngo.

Agree­ing, Ms Tan says if more talk of eco­nomic stim­u­lus or mon­e­tary eas­ing arises from the Fed or the Euro­pean Cen­tral Bank this year, imply­ing that the economies require more liq­uid­ity to aid growth, this will sup­port gold prices. ‘Due to gold’s spe­cial sta­tus as a store of value, we are likely to see sus­tained invest­ment demands, par­tic­u­larly when eco­nomic growth remains uncer­tain,’ she says. Phillip Futures is thus ‘still bull­ish on gold in the long term, with prices likely to test a new high above the US$1,920 an ounce level reached in the sec­ond half of 2011,’ Ms Tan adds.

On the other hand, Fundsupermart’s Mr Wong is ‘cau­tious, if not out­right neg­a­tive on gold’. ‘We believe the bull run, which is now 11 years, has gone on for too long,’ he says, explain­ing that demand for gold, out­side of hold­ing it as an invest­ment, has not shown growth.

One rea­son why he is neg­a­tive is the dif­fi­culty in jus­ti­fy­ing the price of gold. ‘There are no earn­ings which gold can be tied to like tra­di­tional com­pa­nies where val­u­a­tion mea-sures will make more sense,’ says Mr Wong. His view is that gold prices have risen so much over the last few years sim­ply because peo­ple are more will­ing to pay more for it. How­ever, the ‘safe haven’ sta­tus dri­ving this will­ing­ness is ‘sus­pect’, he says, espe­cially as con­fi­dence in the US dol­lar rebounds with recov­ery in the US economy.

Albert Cheng, man­ag­ing direc­tor, Far East, at the World Gold Coun­cil, a gold pro­duc­ers’ asso­ci­a­tion, would dis­agree. Investors need to note that gold is also a com­mod­ity, so the way mar­ket fun­da­men­tals and the dynam­ics of demand and sup­ply change matters.

On the demand side, about half of gold demand stems from demand for gold jew­ellery, over 30 per cent from invest­ment demand and about 8 to 10 per cent goes to indus­trial uses such as in gold wire for elec­tronic goods, while a small por­tion is pur­chased by cen­tral banks, Mr Cheng says.

On the sup­ply side, about 2,500 tonnes come out of the world’s gold mines each year. Another 1,000 to 2,000 tonnes of recy­cled gold is also sup­plied to the mar­ket, mak­ing a total of about 4,000 tonnes of gold annually.

While sup­ply remains rel­a­tively con­stant, demand is likely to keep ris­ing, dri­ven by China’s and India’s ris­ing mid­dle class and their demand for jew­ellery, as well as the rise in invest­ment demand for gold as a liq­uid asset to act as ‘an insur­ance pol­icy to portfolios’.

Mr Ngo agrees that the gold mar­ket will remain bull­ish in the short term, but adds that investors ought to keep in mind that gold is a non-yielding asset with lit­tle indus­trial use, so its longer-term per­for­mance may be lower than that seen over the past decade.

How should a young investor invest in gold?

Apart from under­stand­ing the gold mar­ket and the dynam­ics dri­ving gold prices, a young investor may wish to con­sider how to incor­po­rate gold into his or her portfolio.

‘Young peo­ple would like to take a lit­tle more risk, so in terms of gold invest­ments, their allo­ca­tion would be much smaller, com­pared to peo­ple in their 40s or 50s,’ says Mr Cheng.

With time on their side to ride out eco­nomic cycles, young investors ‘should allo­cate more to equi­ties given that his­tor­i­cally, equi­ties out­per­form most asset classes over the long-term’, says Mr Ngo.

‘How­ever, a small allo­ca­tion in gold could be use­ful to pro­vide diver­si­fi­ca­tion ben­e­fits, espe­cially in times of cri­sis, or may be used as a hedge against infla­tion, defla­tion or cur­rency deval­u­a­tion,’ he says.

While phys­i­cal gold remains the ‘safest way’ of get­ting expo­sure to gold, as it removes coun­ter­party risks, there are issues of space, secu­rity and stor­age costs to look into. ‘As such, gold indices and ETFs, which are backed by phys­i­cal gold, would be the next best option avail­able for investors,’ Mr Ngo says.

Mr Wong prefers gold equi­ties, which can be invested in through resource unit trusts or com­mod­ity funds, as they are more diver­si­fied across com­pa­nies, and ‘even if the gold price stag­nates — a high pos­si­bil­ity in our opin­ion — a gold min­ing or gold related com­pany can still have avenues to raise prof­its by con­trol­ling costs’.

Other options may be to trade gold ‘in the form of Spot Loco Lon­don con­tracts in the over-the-counter mar­ket and in the form of futures, ie, exchange-traded con­tracts in COMEX, CBOT, TOCOM,’ says Grace Chan, direc­tor of mar­ket­ing and sales chan­nel, Phillips Futures.

But this would only be suit­able for ‘savvy investors’, as futures trad­ing involves lever­age which means the investor could sus­tain losses in excess of his ini­tial funds and then may need to deposit addi­tional funds at short notice, Ms Chan says. Only those 21 years and above can open a futures trad­ing account, and need to be assessed to under­stand the prod­ucts in order to trade futures.

By Teh Shi Ning