Inflation is now investors’ number one enemy. It is a global phenomenon and is on the rise almost everywhere. The traditional answer is to buy gold, and now looks a good time to do so.
We know that the official Consumer Price Index showing 3% inflation in the UK is a joke. Real-world inflation here is at least 5%. In Europe and the US inflation rates are over 3% and rising. But this is low compared with the rest of the world.
In India, China, Indonesia and the Phillippines - all countries with big populations - the inflation rate is at or near 10%. In Pakistan it is 17%, in Russia 14%. With rising fuel and food prices worldwide, it’s hard to see inflation slowing down any time soon.
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The ‘barbarous relic’ offers a store of value
When inflation is rising and people see that the buying power of the money they hold in the bank is shrinking, they start to look for alternatives. And the big one, the obvious one, is gold, which has been a store of value for far longer than paper money - in fact for over 3,000 years.
So much so that most central banks still hold thousands of tonnes of the stuff. Uncle Sam holds 77% of his foreign exchange reserves in the form of gold in Fort Knox, while the French and Germans have over 50% of their reserves in gold.
The UK, thanks to Gordon Brown, sold half its reserves at a third of the current price but still has 15% of its reserves in gold. But China has just 2% of its massive reserves in gold and India 8%.
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Don’t buy coins unless you fear societal breakdown
Those figures are higher than they were a few years back because gold has soared in price from $600 per ounce in mid-2006 to over $900 currently. It briefly went above $1,000 per ounce in March 2008 and many analysts expect it to resume its uptrend shortly.
Because the US dollar has been weak, the increase in terms of the pound or euro has been much smaller. As compared with summer 2006, the sterling price has risen from £324 to £460 per ounce.
So how do you buy gold? In the old days, you bought gold coins like krugerrands or sovereigns, but that’s the least good option, because you pay a premium over the actual gold value of between 5% and 15%.
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Buy it, but don’t stick into the back of your mini
In the Middle East and India they buy jewellery, but there the mark-up over the gold value is even higher. Still, jewellery accounts for about 2,400 tonnes of gold a year – which is almost exactly the amount of newly mined gold that comes out of all the world’s gold mines.
If that sounds a lot, bear in mind that you can fit a tonne of gold into a cube measuring just 15 inches per side - which proves what nonsense The Italian Job was, because however much you strengthened their chassis, the minis would never have taken the weight they were supposed to be carrying.
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The two best ways to buy
The two better ways to buy gold that I recommend are Exchange Traded Commodities (ETCs) and unit trusts. ETCs are funds traded on the London Stock Exchange that just own physical gold.
The gold is held in the form of officially validated bars in the vaults of a big bank like HSBC and is independently audited, so the ETC only issues units to investors corresponding to ounces of gold in the vaults.
There are two suitable ETFs, ETFS Physical Gold (PHAU), with an annual fee of 0.49%, and Lyxor Gold Bullion Securities (GBS) with an annual fee of 0.4%. The ETC unit is one-tenth of an ounce. This is a really cheap and simple way of owning gold because if you use an online stockbroker you need only pay a flat £10-15 to buy the ETF.
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Small investors should buy using ETCs
So for any sum from £500 upwards, this is the cheapest, simplest way to own a chunk of gold, and you can buy or sell at any time in stock exchange trading hours.
In the long run, you would expect a mining company to make a lot of money when the gold price rises, because its production costs are relatively fixed. I say relatively, because rising energy costs have a big impact on deep mines like those in South Africa, which use a lot of energy to extract their gold.
Shallower mines in Australia and Canada have lower production costs. But in principle, if a mine can produce gold at, say, $400 an ounce its profits should soar if gold rises to $1,000 per ounce.
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Demand should recover
So in theory an investment in gold mines should be even more profitable than owning physical gold. But shares go up and down for lots of other reasons too, so at times they can lag the gold price and at times leapfrog it. Recently they have lagged, which may mean it’s a good time to buy.
The best UK fund is Blackrock Gold & General, a £1,500 million fund run by veteran Graham Birch, who has shrewdly had most of the money in North American rather than South African mines recently.
The fund has tripled investors’ money over five years and is up 30% over the last 12 months. It charges 5% initial and 1.95% annually, but if you buy through a fund supermarket you can pay an initial charge of as little as 1-2%.
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Right now, the market is nervous about the fact that jewellery demand has dropped about 20% as a result of the price rise, while the supply of scrap metal has risen. In fact this is a normal reaction to a rise in price, and so long as inflation remains a major bogey - especially in India and China where people don’t place much trust in banks – demand should recover in due course, as it has in the past.
I have personally bought the Blackrock fund rather than physical gold, on the basis that the current gold bull market could last several years and see the price doubling from current levels if enough Chinese and Indians decide to store a small fraction of their wealth in this way.
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Important risk warning - please read
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance. If you are in any doubt as to the suitability of an investment, you should seek independent financial advice.
