PensionsJun 24 2016

Going for gold

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Gold is not a traditional investment for a pension portfolio for a variety of reasons, but that hasn’t stopped investors snapping up the precious metal in droves this year. According to the World Gold Council, demand for gold globally rose 21 per cent in the first three months of 2016 – the second highest increase on record.

During the same period, the number of UK pension fund investors in gold rose by more than a quarter, with an average investment of £35,000 according to the Pure Gold Company.

Now the UK’s Royal Mint, spying an opportunity to increase sales, has opened up to self-invested personal pension and small self-administered scheme investors for the first time since gold was made an eligible investment in 2014.

Pension investors can now trade gold 24/7 via the Royal Mint website. You too could be the proud owner of a 100g gold bullion bar – or part of a 400g bar – lovingly stored in The VaultTM. All very exciting. But does investing in gold make investment sense?

As a general rule, commodities do not make ideal long-term investments, which is why many large pension funds and endowments tend not to make allocations to the asset class at all. The trouble is that they produce no income, unlike a bond, which pays interest, or an equity, which pays dividends. This means that commodities have no intrinsic value – there is no reason why they should be worth more in the future than they are today. Commodities simply rise and fall in price depending on the dynamic between supply and demand.

Super-cycle theory

Champions of the super-cycle theory will argue that as the world’s population grows and the commodity-consuming demands of emerging markets increase, prices must rise over the long term – just as they did in the first decade of this century. But that trend started to peter out in 2012 as supply caught up with demand – and as big commodity consumers like China started to slow down and eat less rapidly.

The trouble for investors with very long-time horizons – over 10 years – is that there is no compelling economic case for commodity prices continuing to rise. And without capital appreciation there is nothing to be gained from commodities. At least with an equity or bond the investor is compensated with cash flows that can, to some extent at least, be quantified and valued.

However, gold has never been a typical commodity. Investors use gold as a currency in its own right (although it is always denominated in US dollars) and as a store of value. This means it is an asset that will always be sought after and, therefore, will always have value.

On top of that, gold is used in the manufacturing of electronic components and computers as well as jewellery. It even has a role to play in modern medicine.

Versatile currency

Its versatility and high practical value, as well as its extraordinary long life and limited supply, made gold the original currency for early civilisations. At one time, physical gold stockpiles were used to back paper currency in the US and UK, and even now governments around the world maintain stores as emergency supplies, although the UK’s is somewhat depleted after Gordon Brown’s infamous policy of selling down half of our gold reserves from 1999-2002.

All of this makes gold unique among commodities, and a popular investment choice by many as protection against major global crises. Demand for gold – and therefore its price – tends to rise when global risk appetite is weakest, such as in the wake of the Lehman Brothers-inspired financial crisis. For many investors it is the safest asset of all because it will always be valued by others, no matter what happens.

This year, gold has been a runaway hit, which is why interest has spiked among UK pension fund and global investors.

The explanations have been many and various: the increase in volatility in the stock market, for example, weak risk appetite, fears of a possible global recession emanating from China, high valuations of stock and bond markets, and persistently low interest rates that make other low-risk options less attractive. All of these explanations are fleeting and not unprecedented.

Exchange-traded funds

One dynamic that is relatively new, though, is the boom in gold exchange-traded funds (ETFs). While the Royal Mint will be hoping that the allure of physically owning gold bullion bars will attract Sipp investors, the ongoing fees – at 1 per cent a year – are a bit steep.

Contrast that with investing in a gold ETF for as little as 0.25 per cent annual management charge and a high degree of liquidity, and it is not difficult to see why the ETF option has quickly gained traction from retail and institutional investors.

As at 11 May, two leading gold ETFs alone had seen inflows of $9.4bn (£6.6bn) in the first five months of the year, according to ETF.com.

The growing popularity of gold ETFs has been cited as one of the reasons why the price of gold has risen so fast this year (21 per cent return for the year to 13 June), while demand from the biggest markets for gold – consumers in India and China – has substantially fallen.

It is no coincidence that the rapid rise in the price of gold this year has occurred during a very choppy period for the stock market, and at a time when other safe options such as government bonds offer historically low yields, giving them very little advantage over gold. But the fall in demand from gold’s biggest markets is a concern, fueling speculation that ETFs are helping to create a bubble caused by speculators.

Traditional investment

Should economic data improve, stock markets recover and interest rates rise, gold could well lose its attraction for investors who would be tempted by more traditional investment options.

Without gold’s mainstay markets to support it, the price could come under pressure. And this encapsulates the difficulty with gold as a long-term investment. The precious metal goes through boom and bust periods for a variety of complicated reasons that a savvy tactical investor can take advantage of.

For a long-term. buy-and-hold investor, gold can help to diversify a portfolio because its price tends to have a low correlation to traditional equity and bond assets.

In bad economic scenarios, gold is likely to provide a solid buffer. But it is difficult to have a high degree of confidence that, all being well net of inflation, gold will rise in value over 20 years to outperform similar low risk assets like bonds.

Bob Campion is head of institutional business at Charles Stanley Pan Asset