The golden years are back

Did you ever think you would see a run on a bank in your life time? The answer for the vast majority of IFAs and wealth managers would have to be a resounding no. Yet Northern Rock happened and – as Alan Greenspan, Paul Volcker, George Soros, Warren Buffet and others have warned – we are now facing the greatest financial and economic crisis since the Great Depression.

IFAs and wealth managers are confronted with unprecedented macroeconomic and systemic risk. The IMF has warned that if another major bank fails it could take down four or five of the world’s largest 15 banks with it. Obviously this has serious ramifications for the stability of the global financial system and economy.

Did you ever think you would see oil rise some 1000 per cent in a matter of years to more than US$110 a barrel and see the spectre of serious inflation or, worse, stagflation? Ben Bernanke, the Federal Reserve chairman, recently warned of the risks posed by slowing economic growth and rising inflation.

Commodity prices, including base metals and soft commodities, are surging and the dollar continues to depreciate and this is causing real inflationary pressures. Inflation will dramatically affect the value of bonds and cash and prudent wealth managers need to look to assets which perform well in such a macroeconomic environment. Gold thrives in such conditions as was seen in the 1970s when it rose from $35 to $850 for a return of nearly 2500 per cent in just nine years.

As all good portfolio managers know, the most important factor affecting long-term investment performance is asset allocation. In order to achieve a diversified portfolio, the manager is looking for non-correlation of assets.

Recent studies – for example by Jastram and Smith, Colin Lawrence and Knox – have concluded that gold bullion was not only negatively or insignificantly correlated with equities and property, but that it was not related to macroeconomic variables such as GDP and that it is a good hedge against adverse inflation and interest rates.

Gold is an extremely effective portfolio diversifier and it has been rising in all major currencies including sterling and has performed extremely well for UK investors. The last time we had similar conditions to today – slowing growth and rising inflation in western economies – gold rallied very sharply in all international currencies.

Gold rose from below £20 an ounce in 1971 to £300 an ounce in 1980 or a rise of some 1500 per cent. Were gold to replicate its performance of the 1970s again, gold would soar to multiples of the multi-year low in sterling below £200 an ounce in 1999, when Gordon Brown very short-sightedly and imprudently sold much of Britain’s gold reserves. Many analysts expect gold, at the very least, to reach its inflation-adjusted high of more than some £900 an ounce and $2000 an ounce in the coming years.

Private investors can invest in gold through a variety of very different mechanisms. These include exchange-traded funds, equity-based unit trusts and investment trusts, allocated and unallocated accounts and government gold certificates.