Buyer beware

After breaking several all-time highs this year, the gold price hit a patch of volatility towards the end of August. Experts remain divided as to where the precious metal is headed next
Buyer beware
The cost of gold has surged 24 percent so far this year, well on its way to achieving its eleventh consecutive year of growth
By Claire Ferris-Lay
Mon 05 Sep 2011 02:04 PM

“There are many disbelievers about gold. I remember going on Bloomberg Television when I bought it at $1,000 an ounce, and them telling me how crazy I was buying when it was breaking and out making a new high.”

Damon Vickers, managing director and CIO of Seattle-based Damon Vickers & Co, went on to prove those nonbelievers wrong. A month ago, on the day that gold struck $1,784 an ounce, his investment firm sold all of its gold assets.

“On Monday and Tuesday [8 and 9 August] there wasn’t anybody that didn’t want to own gold; nobody. The world was coming apart, our credit rating was downgraded, the stock market was going down 500-600 points and not only was gold holding up, it was going up,” adds Vickers, who says the sale resulted in “considerable profits”.

The cost of gold has surged 24 percent so far this year, well on its way to achieving its eleventh consecutive year of growth. The precious metal peaked at $1,886.50 two weeks ago and posted its biggest weekly gain since April 2009 as European and US stock markets plummeted amid concerns over debt levels.

And then came the drop; during the course of that week, better-than-expected economic data and some profit-taking saw the price drop by $170 — its biggest fall since 2008. But by the close of play on Friday 25 August, the value had recovered to $1,788. Swiss bank UBS raised its one-month price for the precious metal to $1,950 from $1,725 and its three-month prediction to $2,100 from $1,850.

Gold has always been seen as a safe haven during volatile times but several days of consecutive growth during the second week of August left investor opinion on where its headed next sitting on two very distinct sides of the fence. Could it reach $2,000 an ounce? “That’s just silly, I mean it certainly could. Gold could go up to $10,000 an ounce, it could also go back to $300,” says Vickers.

“Ultimately the gold price will overshoot, it will peak,” adds Neil Gregson, portfolio manager, Global Equities Team, JP Morgan London, whose natural resources fund held 37.6 percent of its portfolio in gold and other precious metals on 12 August.

In 1971, then-US president Richard Nixon ended the convertibility of dollars into gold in a bid to bring down inflation and a deteriorating balance of payments. The move signalled not only the end of the Bretton Woods system — under which fixed exchange rates were linked to the gold price — but also the end of an era of a financial system anchored to gold.

Today, some forty years later, it looks like gold could be reclaiming its dominant position within the financial system. For some time central banks, hedge funds and even those with little or no experience of gold have been flocking to the precious metal in their droves amid concerns the global economy could be plunging into a second recession.

Central banks in Thailand, South Korea and Kazakhstan added a total of $2.56bn of gold to their reserves in July, following in the wake of Mexico and Russia both of which have increased their investments in gold so far this year. As of 17 August, the US held 74.2 percent of its reserves in gold, Germany 71.4 percent, Italy 71.2 percent, and France at 66.2 percent, according to stock trading analyst Kurtis Hemmerling. Globally, central banks bought around 280 tonnes of gold during the first half of this year, according to data from the World Gold Council.

The last time central banks bought gold in such large quantities was in the 1980s when gold reached a then-record of $850 an ounce. “For the first time in 21 years we saw last year — and are seeing more of it this year — net buying by central banks, so the gold price rally has gone global,” says Gregson.

Central banks aren’t the only investors looking to secure their assets amid the turbulence of the economy. Dubai’s Gold Souq traders say they have seen a 100 percent increase in the sale of gold bullion to the general public in the last six months.

“I would say in the past six months it has least doubled; before I used to get one or two customers [buying bullion], now it’s at least four to five customers per day,” says Chetan Dhakan of National Jewellery.

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In August, the Dubai Multi Commodities Centre Authority unveiled a prototype of the country’s first gold bullion coin aimed at targeting members of the general public interested in gold. DMCC is currently in talks with the UAE Central Bank to designate the five ounce gold coin, which is worth around $8,167 at current prices, as the first gold bullion legal tender in the Middle East.

“The innovative gold bullion coin was conceived to satisfy the demands from investors seeking access to gold as protection against the ongoing global economic uncertainty,” said Ahmed bin Sulayem, the executive chairman of DMCC.

Gregson says the current gold rally is being buoyed by individual investors. “What we've seen over recent weeks is, yes the hedge funds are there but the dominance has been retail buying. It's mums and dads globally buying coins and bars,” he says.

But why the sudden interest in gold? The yellow metal has always been seen as a safe haven but a series of events both sides of the Atlantic have helped spark the most recent rally. While on one side of the pond Standard & Poor’s decision to downgrade America’s prized AAA credit rating dealt an unprecedented blow to the world’s largest economy, concerns over Europe’s debt crisis mounted.

While stock markets the world over nose-dived, gold prices rallied. “Gold is a fantastic barometer which is the sum of all of those economic, social and political concerns and best reflects how people broadly feel,” Ross Norman of London-based bullion brokers, Sharps Pixley, said in an investor note.

In the days following the initial rally, prices stabilised somewhat before increasing again following a meeting between French and German leaders which yielded few solutions over the Eurozone’s debt problems. Concerns over Europe and the US aside, the fourth quarter of the year is traditionally a strong period of gold as a series of festivals in India followed by Christmas and Eid trigger jewellery buying.

How high it could reach before the end of the year is anyone’s guess. If recent moves by the hedge fund manager George Soros are anything to go by gold may already have reached its peak. The billionaire, who in January declared gold the “ultimate bubble”, dumped almost his entire $800m stake in bullion in the first quarter of year, reducing his investment to just over $6m.

Soros isn’t alone. US hedge fund Jana Partners founder Barry Rosenstein —  who in the last three months of 2010 bet $122m on gold — sold about a quarter of his stake in gold in the second quarter, according to reports. New York's Touradji Capital Management, which has $3.5bn in assets under management, sold its entire $25m stake in the same quarter.

Nigel Green, CEO of the De Vere Group, says now is the time to be getting out of the gold market not getting into it. “I believe gold should only be purchased by investors with a very negative view of the future of the economy in the US and Europe. For me, gold should only be sold at these prices, not bought,” he says.

But not all investors share these pessimistic views. In fact some fairly big players are banking on gold continuing to rise. John Paulson of the US hedge fund Paulson & Co — who is estimated to be worth $16bn by Forbes — kept his holding in the SPDR Gold Trust unchanged in the second quarter of this year, according to a filing to the Securities and Exchange Commission. Deutsche Bank commodity trader Hal Lehr told Bloomberg he thinks it could reach $2,000 an ounce within eight months.

“Back in 1979 to 1981 (the last time that central banks were net purchasers of gold) every man and his dog were buying gold coins so it could eventually be a sign of the beginning of the end. But [US Federal Reserve chairman Ben] Bernanke holding interest rates close to zero for two years [provides] a fantastic environment for gold. The comments on currencies and inflation or deflation are going to keep that interest in gold for some time to come,” says Gregson.

Gregson isn’t alone. Norman of Sharps Pixley says the six months could be a good period of time for the precious metal. “[We] remain confident that ongoing upside for gold exists — certainly for at least six months,” he says in his note.

“We had forecast a top for gold at $1,850 in 2011 and an average for the year of $1,513 — we may have undershot a little — which is atypical of us. Gold has averaged $1,477 so far this year and if it holds current levels then a figure closer to $1,600 is on the cards,” he adds.

How can you invest in gold?

Buy Funds

One of the easiest ways to buy gold is through an Exchange Traded Fund (ETF), which is a financial tool similar to a mutual fund whose value depends on the price of gold. Unlike a mutual fund, ETFs must be purchased and sold on a stock market so investors need to sign up with an online brokerage firm first. ETFs are typically easier to trade than mutual funds and the costs are usually lower. Brokerage firms provide leverage against the initial investment which means investors don’t have to commit to the total amount they are trading. The disadvantages are that the gains are not always direct and can lag in gold prices and there is always a risk that prices can rise and fall quickly.

Buy physical gold

“This is the old fashioned way; you go to the shop, buy the gold and take it home,” says Mohammed Younis from Gold AE. The advantage of purchasing gold is that when the price increases, the value of your gold increases on an almost one-for-one basis unlike other assets that only track the value. It is also easy to liquidate, says Younis. “There are always buyers for gold.”

Buy gold papers

Want to buy gold but don’t have anywhere to keep it? Buying gold papers or certificates could be the best option for you. Investors can purchase a gold certificate from a bank — Emirates NBD for example sells certificates — in lieu of physical gold at international market rates at the time of purchase. Buyers can sell the gold back to the bank at any time they want.

Buy stocks

Go direct to the source and invest in gold mines. Gold might have reached several peaks in the last few weeks but the price of gold mining stocks have continued to decline. That could be changing soon. “[During] the market turmoil we did have some days when gold shares were up strongly when the market was down overall [and] we are aware of renewed investor interest in gold shares,” says Neil Gregson, portfolio manager, Global Equities Team, JP Morgan London.

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