Last week saw the price of gold climb strongly, bringing July's total gains to
around 10pc. Gold ''bugs'' – those who are committed buyers – pointed to market
data, including the prices of contracts by which traders speculate on gold's
future price, as evidence that ''a corner had been turned''. Is this really the
case?
What has happened to the gold price?
Having peaked in autumn 2011 at almost $1,900 an ounce, the price fluctuated
between $1,600 and $1,800 for much of the next year, before beginning a sharp
decline from October 2012. Last month it fell below $1,200. During this month
though it has rallied, climbing more than 3pc in a single day. It is still below
$1,400.
What has happened to shares in gold mining companies?
Most have plunged far further than the price of gold. This has had a direct
impact on British investors in popular commodity funds which hold mining company
shares, such as Junior Gold, BlackRock Gold & General and JPM Natural
Resources. These three widely owned funds have fallen in value over the past 12
months by 51pc, 25pc and 11pc respectively. Apart from the fall in the gold
price, miners have been hit by rising wage and energy costs.
What factors drive the price of gold?
There are supply and demand factors as for any commodity. But there are also
more subtle factors reflecting investor sentiment and gold's unique history as a
repository of wealth.
The greatest demand for the physical substance comes from the jewellery
industry. There is also demand by technology sectors where gold is required as a
component, and by investors. "Price formation" tends to be driven by investors,
as they can most readily buy and sell gold. So although investors account for a
relatively small proportion of the overall demand for gold they play a large
part in driving short-term price movements.
Why do investors want to own gold?
Not all do. But wealth managers, banks and fund managers have increasingly
noticed gold's non-correlation with other assets. In other words its price does
not move in line with the value of shares, bonds, property and other commonly
held investments, making it useful as a diversifier of risk. It is not uncommon
for wealth managers to recommend all clients hold some gold – typically less
than 10pc – in their portfolio.
It is also held as a hedge against inflation, which is why its price often
reacts to actions or statements by authorities relating to wider price rises.
Tom Stevenson of Fidelity, the asset manager, said of last week's gold price
resurgence: "Gold received a boost after a Bank of Japan board member hinted at
further monetary stimulus. Gold tends to rise when worries about excessive
stimulus increase."
Why does gold generate such extremes of opinion among commentators?
Gold excites strong and sometimes emotional responses. Buyers of gold include
ultra-cautious investors, even some who believe world order could collapse due
to economic forces, war or anything else. Hence providers of gold bullion
storage, for example, offer services where clients' gold can be stored in a mix
of foreign vaults accessible through the release of keys and codes if, for
instance, the unthinkable happens and world cities like London or New York are
destroyed.
The rise in the gold price has also sharpened opinions on either side, with
gold bugs and bears expressing more strident views.
What are the easiest ways for private investors to own gold?
By far the easiest is through shares in physical gold exchange-traded funds,
such as ETFS Physical Gold. These can be traded via any stockbroker and each
share – listed on the London Stock Exchange – is backed by real gold stored in a
vault.
Other businesses, such as BullionVault or the Real Asset Company, provide
markets where small investors can buy or sell bullion which is securely stored
on their behalf.
Why I'm bullish about gold...
Marcus Grubb, managing director of investment at the World Gold Council,
London, said: "Unless you believe that the global economy is heading for a
strong and sustained recovery where central banks will allow interest rates to
rise above inflation, you'd have to conclude that the bearishness we have seen
is excessive.
"The reality is that central banks have little choice but to keep interest
rates very low to stimulate growth. And inflation is likely to be maintained at
higher levels, with currencies like sterling remaining weak.
"We might have talk of 'tapering', or anxiety about the beginning of the end
of quantitative easing, but in reality the Fed and the Bank of England will have
to keep applying stimulus for several years. We will go into a phase where we
will see an on-off approach to managing the economy. And that will be very
supportive to the price of gold."
Mr Grubb said the supply of gold will contract as less is mined and less is
"recycled" into purer form from existing.
...and why I'm not
James Sutton of JPMorgan, the global fund manager, said: "We took a decision
to reduce our exposure to gold and precious metals toward the end of last year
because we think there are signs of a pickup in economic activity and industrial
production.
"Other sectors, such as base metals, are likely to recover more strongly than
gold. There are tentative indications that the rout in the gold market may be
over, that's true. But gold is a murky market. The view we take is that gold
becomes less attractive if you believe we are moving slowly toward recovery."
He argued that China's infrastructure spending is growing and that in Europe
"there only needs to be a change in sentiment for there to be a pickup".
He believes some gold mining companies are now attractively priced, but
added: "When something falls by 60pc to 70pc, it doesn't take much to move off
the bottom."
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