The value of the precious metal soars in difficult times — owing to limited reserves and difficulties of extraction — but investors should beware the pitfalls if they are to achieve maximum returns.
Recent record-breaking gold price highs have placed this asset class firmly in the spotlight. Gold is seen as a hedge against inflation, a constant in uncertain times. It is viewed as a debt-free currency which always maintains a physical value. For these reasons gold remains coveted.
The economic environment is supportive for gold as inflation fears come into play again. Nevertheless, the price paid today for the inflation and dollar insurance that gold provides is fairly high. A further price development for gold — above $1,100 per ounce in 2010 — is likely. However, it has to be driven by real physical demand, rather than speculative sentiment only.
In the long-term, gold should continue to appreciate in value because world reserves are restricted. All the gold that has ever been mined is equal to a cube measuring 20 metres on each side.
While demand from the jewellery industry has slackened in recent months, demand from investors has more than compensated, and this will continue as they seek to invest in the yellow metal as part of their strategic asset allocation.
After peaking at 2,654 tonnes in 2001, gold production has since been in decline. Lower reserve grades, ore deposits in more challenging geologies, and technological limitations to extraction will all contribute to a continuation of this downward trend. These factors increase the time involved to get the metal out of the ground and the cost of exploration.
Financing is also a significant problem. As the development of new gold-fields takes several years, long-term investment projects are needed. However, these are called into question as they depend on credit financing, and in many cases this has already either been withdrawn or has become massively more expensive.
Gold is used to help optimise the risk/return profile of portfolios. It has a low correlation with other asset classes, providing attractive diversification benefits.
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