April 2009

GOLD FUNDS: going for gold

Sales of gold funds have been impressive during the financial crisis. But Angele Spiteri Paris finds that pension funds may prefer to hold physical gold rather than ETFs and other fund structures... goldsafe.jpg The value of gold increased as the financial crisis unfolded. Its price reached a high of US$1,000 (€754) per ounce in February 2009 as investors fled to this reputed safe haven.  Meanwhile, net sales of gold funds in 2008 totalled €2bn, according to Lipper Feri – 17 times the inflow seen in 2007.

Although not necessarily true, gold is perceived to be negatively correlated with stock markets. Does this mean fund sales – and the underlying metal itself – will decline when economies pick up?

“It would be fair to say that gold’s safe haven appeal was somewhat reduced by rallying equity markets,” says Andrey Kryuchenkov, an analyst at VTB Capital, a Russian investment firm.

But if investors do eventually sell gold to invest in equities again, future economic stability will not necessarily mark the end of the gold investment story, some believe.

Bradley George, head of global commodities and resources at Investec Asset Management, says: “The reasoning behind gold investment is two-fold. If you believe there is going to be an inflationary environment down the line, then people will seek physical assets to protect them.

“On the other hand, there are those who are safe-haven buyers. They don’t want to put their money into any particular currency and are concerned that interest rates will remain extremely low.

“I think there would be some concern about the gold price were an economic recovery to come. If they see global growth coming back, then the safe haven buyers could sell their gold and move back into riskier assets so the gold price could come under pressure.”

Peaks and troughs
Hervé Lievore, investment strategist at Axa Investment Managers, says: “There is an amazing convergence between the different phases of gold prices and market sentiment. Gold reached its first peak in the middle of March 2008. The turning point then was the JPMorgan bail out of Bear Stearns. After this, market sentiment improved and gold prices started to fall.”

Lievore explains that peaks and troughs in gold prices continued throughout the year in tandem with upheaval in the financial world. The bailout of Fanny Mae and Freddie Mac saw gold prices fall while the collapse of Lehman Brothers led to a surge in gold prices.

Peter Lucas, investment strategist at RBC Wealth Management, adds: “All of the big bull markets in gold have corresponded with equity bear markets – the 1930s, the 1970s and this current crisis. The low in gold corresponded almost exactly with the high in equity markets.”

Marcus Grubb, head of investment at the World Gold Council (WGC), says: “It’s not true that there is a negative correlation between equities and gold as a long-term relationship, but it is true in a crisis like this, which is being driven by a failure of the financial system and a now deep recession.”

He feels that the depth and intensity of the current crisis could result in more cautious investing, which would affect the demand for gold.

The future’s gleaming
“If there is a more structural shift towards more prudent risk management and portfolios in the future then gold demand would be higher, because it’s a good diversifier.”

Therefore, a recovery in equities won’t necessarily see a downturn in gold.

Lucas, at RBC, says: “Interest rates would have to rise substantially to make a non-yielding asset like gold unattractive. My analysis indicates that ten-year US government bond yields would have to rise above 5% before gold gets into trouble, and clearly we’re a long way away from that.”

Investment demand for gold was up 60% in the fourth quarter last year, as compared to the same period in the previous year. Jewellery demand is still significant but this is falling because of the crisis.

“Although this is certainly very supportive for the market, it swings violently and is much more elastic than jewellery demand,” Kryuchenkov, at VTB Capital, says.

However, the crisis is not totally responsible for the investment demand. Grubb, at the WGC, says: “Gold demand doubled since 1995. Although the crisis is having an impact on sentiment, the pickup in volume of gold investment started back in the late 1990s.”

Pension funds
There are several ways of investing in gold – for example through exchange-traded funds (ETFs), or futures and options. The vehicle largely depends on the investor and their reasons for investing in gold.

For pension funds, there may be difficulties with fund structures, however.

Dennis van Ek, principal at Mercer Investment Consulting in the Netherlands, says: “The large problem with a gold ETF is it does not fulfil the insurance role that gold should have for a pension fund. This is because, rather than a full backing by physical gold, there are banks behind the ETFs.” 

Now that many banks are partly state owned, Van Ek explains there could be an issue with cashing in a gold ETF when a government finds itself in trouble.

“Getting your payout serviced by the bank may be a problem in this scenario. ETFs are fine as long as things don’t go terribly wrong.”

He adds: “If you want to invest in gold for safety from currencies and governments, then physical gold is the way to invest. For ultimate safety one may choose to invest out of Europe and out of the US, whose fiat money systems are now under pressure as a result of monetary inflation and credit expansion.”

One of Mercer’s pension fund clients divested out of financials last year and began investing in gold. Van Ek says another two pension funds are due to follow.

The investment was made with the Perth Mint in Australia. The mint makes bars and coins out of raw gold and has developed investment products.

Van Ek says: “The legal representatives from pension funds can actually take the gold out of the vault. It’s protected and you simply pay a fee to keep it safe. Even if it’s stolen, it is guaranteed and insured by the Federal State of Western Australia and Lloyds of London.”

This means that if investors think the world is going to end, they will still have their gold – they just would need to go to Australia to pick it up.

©2009 funds europe

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