Gold: precious revival or false dawn?

Gold has been one of the most interesting investments of the past decade, due to a meteoric rise in price that saw the cost of a troy ounce of the yellow metal soar from $804 (£494) in September 2008 to its peak of $1,921.50 just three years later.

As the date range would suggest, this was largely due to the global financial crisis. As equity markets sold off and bond yields plummeted, investors piled into what has long been considered a "safe" asset that retains its inflation-adjusted value, regardless of market movements.

After remaining range-bound throughout 2012, the gold bubble finally burst in December 2013 when the price of a troy ounce dropped to its most recent low of $1,197, as investors returned to mainstream markets ahead of imminent interest rate rises.

This year, however, a spike in geopolitical tensions in Ukraine and the Middle East led to an unexpected rally in the price of the largely unloved asset, with the price peaking at around $1,380 in March.

Gold funds' strong gains

Combined with disappointing economic data from Europe that has stoked fears of a slowdown in the global recovery, this has led to some strong gains for global gold funds, which have also benefited from the well-publicised restructuring of a number of mining firms.

Top-performing funds include MFM Junior Gold, which delivered an impressive 22.7% in the three months to 31 August, closely followed by WAY Charteris Gold & Precious Metals Elite and Money Observer Rated Fund Investec Global Gold, with three-month returns of 22.3 and 13.2%, respectively.

This marked quite a turnaround for these funds, which over the year to 31 August all lost between 10 and 15% of their assets on a cumulative basis. The pick-up prompted Ian Williams, manager of Charteris Gold, to boast to Financial Express that his would be the best-performing fund of the year.

However, gains did not last long; two weeks into September and three-month returns have slipped to below 3% for all of the above funds, as the gold price has fallen from $1,314 on 14 August to $1,238 on 16 September.

According to Tim Cockerill, investment director at financial advisory firm Rowan Dartington, a drop in the price of physical gold tends to impact on gold-mining companies - and hence the gold funds that invest in them - quite hard, particularly as miners tend to be highly leveraged and poorly run.

"Gold-mining companies haven't been in the best of financial health and they are not the best-run companies you can find; that's why you get that exaggeration in the performance of the gold price, both on the upside and on the downside," he explains.

ETF exposure

For this reason, Cockerill recommends that anyone interested in investing in gold should do so through an exchange traded fund (ETF) with replicated holdings in the physical metal, which are also cheap to hold and easy to trade on a secondary market.

A glance at the performance figures shows that gold ETFs tend to be less inspiring than their mining counterparts, with ETF Securities' Physical Gold ETF returning just 4% in the three months to 31 August, in contrast to the huge gains from MFM and Charteris mentioned above.

However, gold ETFs do tend to lose less when the gold price tanks, making them less volatile and generally better over the longer term; for example, ETFS Physical Gold has returned 22% over five years compared to a 65% loss from MFM Junior Gold.

There are those, including Gary Reynolds, chief investment officer at Courtiers Wealth Managers, who question the need for gold in a portfolio at all. In particular, Reynolds points to the oversupply of gold in the market.

He observes that only around 10% of the annual global supply of gold is put to practical use within industry or through jewellery, and that demand in these areas is often met if not exceeded through scrap or recycling.

As an example he claims that in the first quarter of 2009 the entire demand for jewellery was 370 tonnes, while scrap totalled 610 tonnes. This means over 90% of the gold market is based on investment speculation, which Reynolds believes makes the precious metal nothing more than a "Ponzi scheme".

"A Ponzi scheme just relies on someone else buying it off you in the future; you need the next buyer coming in to pay the existing people. So gold resembles as much of a Ponzi scheme as people could ever possibly imagine; it borders on lunacy," he concludes.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.