Bars of gold

Why gold scores a hit in the recession

One of the surest signs we are in recession is that the markets are awash with investors pumping their money into things rather than concepts. Precious metals have never been a safer bet. Especially gold. E&T reports.

When this article was commissioned, one of the first things the editor said was to consider the precious metals by all means, but above all to consider why some are worth more than others. 'Think about something like gold,' he said, 'whose value is intrinsic, as opposed to steel, whose value is in the application.'

It's not fair to pick on a casually tossed word when someone's actually taking the time to throw paid work at you. But the really interesting thing about gold is that it has no intrinsic value at all - its value is the exact opposite of intrinsic. Yes, of course it's rare and we all know that (that's 'rare' as in 'the High Street is full of jewellers selling it') but its density militates against using it in tools or any other industrial application. You could argue, pretty successfully, that gold investments represent the perfect market; if people went off it, or it fell from fashion, the market would simply fall apart.

And yet it's one of the better investments to be in when the economy is troubled, explains Martin Arnold, senior researcher at ETF Securities. Put simply, when times are tough people would prefer to invest in things rather than in concepts.

Gold is a special case as a precious metal because of its background, explains Arnold. 'The reasons for its value are twofold,' he says. 'First, it's been used as a pseudo-currency for several hundred years. Second, there is the lack of abundance.'

The historical point is important, and it goes beyond the currency idea. Planet Earth plc has a long standing historical love affair with gold, in spite of platinum being rarer and also harder to extract - former analyst Nick Bias explains that, as a polymetal, platinum in the raw is often bonded with as many as 15 other metals, and any mining company needs to factor in the cost of extracting it from the rest before settling on a price - we do like our gold. Ancient civilisations imagined it trapped the sun in some way and concluded that it had healing properties. It has more than a whiff of prestige and power - you never hear of people having platinum-topped teeth, for example, or a pot of bronze at the end of a slightly rubbish rainbow. This shouldn't affect objective, business-run markets but we all know it does.

Uses of gold

Only about 10 per cent of gold is used in industrial applications. The rest goes into jewellery or is put in Swiss bank vaults so nobody can see it - although this is predominantly a Western hemisphere thing, explains Bias. 'In Japan they like to wear their investments more, so they're inclined to deck themselves out in platinum,' he says - we just don't do that over here, platinum jewellery is actually rare beyond its scarcity value. It's in Japan, on the other hand, where a small minority of people buy platinum in bar form, smaller than gold bars but available in the East.

The 90 per cent of gold that exists in investments and jewellery is doing well at the moment because it's a tangible thing. 'Many investments exist only on paper; with gold you're not investing in a future, or a prediction, you're investing in something that actually exists,' says Arnold. This works in gold's favour from a number of angles, he says. 'In terms of futures, derivatives and company shares there can be a virtually infinite supply.'

This is never truer than when you're dealing with a global economy that has entered an uncertain phase and nobody knows when it's going to exit. At the time of writing the Japanese government has just intervened in its Forex markets because of economic pressure, while the UK's policy of quantitative easing might have helped the economy overall but the markets weren't always wild about an idea which simply activated more cash. It's clearly not possible simply to create more gold in the same way that the Chancellor of the Exchequer can create more money, which is why people tend to retreat into gold and metals when the economy is tough, Arnold says.

If this is true on the one hand then the converse is also valid. Arnold is rightly careful to stress that he is not a financial advisor so his views should not be taken as an entreaty to buy or sell any stocks a reader might have, but anyone considering investing would need to look at the timeframe.

'In any investment you need to look at how risk-averse you are, but gold and precious metals behave in particular ways,' he says. 'It's often seen as a safe house and a repository of value when other things are performing less well, but after a couple of years if we have a sustainable recovery it might start to fall again.'

How to invest in metal

There are three main ways of investing in metals, explains Dr Jonathan Butler, publications manager of metal specialist Johnson Matthey. The first is the Exchange Traded Fund (ETF), which looks like a paper investment but is in fact backed up by physical gold somewhere - think about the gold standard all those years ago in currency; an ETF is a similar idea. There are a few of these in the UK and one opened in the US last year. The second is the coin and bar, in which a collector might invest, and in Japan there are now the platinum bars mentioned previously.

Introducing platinum and indeed palladium into the mix - blurs the issue around how the markets behave. It should be stated straight away that all of the precious metals will shadow gold in the way their prices behave, but the variance in the platinum and palladium markets are more responsive to the external world conditions.

This is because whereas only 10 per cent of the gold market is rooted in industry, palladium and platinum go into autocatalyst systems in the automotive market (palladium into gasoline engines and platinum into diesel engines) and the balance is about 50/50 - some analysts say 60/40 but can't seem to agree in favour of which - between investments and industry.

Dr Butler was compiling his company's Platinum Report as this article went to press and a number of things were coming to light - not least that the price was back on the way up. 'Last year platinum reached $1,000 per ounce and now [September] it's reached $1,600.' It's tracked the gold price, which has gone up, as we'll discover, but it's also tracked the automotive sector pretty closely. 'Last year automotive was very flat but we're now seeing a recovery.'

Gold, as the lead item in the metals markets, has enjoyed a chequered reputation in history as a barometer of an economy's performance. Just outside living memory by now, probably, is the Wall Street Crash, which was famously sparked by someone wandering into an American bank and asking for gold to match their cash. The gold standard was abandoned shortly afterwards and it's now accepted that the 'I promise to pay the bearer' wording is largely symbolic, but it brought a nation or three to their knees at the time.

More recently, during the 1970s oil crisis, it was a safe haven for funds needing to retain value while the other stocks and shares were plummeting, much as is the case at the moment, although arguably it played its part in bringing about the current financial situation. Will de Lucy is managing director of Amplify Trading, which trains graduates, city workers and entrepreneurs in the ways of trading and one of the seminal incidents his organisation mentions on the course is the then Chancellor of the Exchequer Gordon Brown selling chunks of the UK gold reserve between 1999 and 2002. 'He did this in the belief that by following his economic strategy boom and bust was a thing of the past and gold would no longer be needed as a hedge against inflation,' says de Lucy.

Hindsight is 20/20, and it doesn't like to see that Brown received between $250 and $300 an ounce.

The later (now former) UK Prime Minister Brown was clearly mistaken in his assumptions but drawing a chart of the price fluctuations since that point one can't help conclude it looks a lot like a bubble.

'The recent movement in gold has continued to be bullish as a break above $1,000 an ounce was consolidated at the end of 2009 opening the door to the high of $1,265 that we saw this June,' says de Lucy.

The question is whether movements downward since June mean the bubble has actually burst. He thinks not, because of the way the rest of the markets are behaving. 'A prudent view of economic development is that the crisis has now moved from a threat of bank default to the potential threat of sovereign default,' he says. 'As governments have extended their borrowing there are concerns that some nations may not be able to sustain debt repayments in the event of another downturn, thus increasing the demand for safe heaven assets away from government debt such as gold.

'Further to this, some countries, such as the UK, may also be faced with an inflation problem as well as growth concerns, further increasing the inflationary proof investment of gold.' As we established, in the 1970s (for example) during the oil crisis, the precedent seemed pretty clear; inflation set itself at an unprecedented high and gold still outpaced it. Other metals, including silver (which has a number of the same emotive hooks as gold) followed suit. Is it too simplistic to say that people will put their trust in things rather than services at a time of crisis? In many instances it appears not.

Johnson Matthey's last report appeared in May and has a number of interesting facts about platinum and palladium. Platinum demand was down by 11.9 per cent in 2009 because of the automotive market - there was a fillip because of the scrappage scheme but when this went down so did the market overall - in fact the gross automotive sector demand fell by a whopping 39 per cent. The jewellery industry's demand for the metal, meanwhile, went up by 46.1 per cent.

The question many readers will want to answer is whether these commodities are worth investing in or whether it's best left to the specialists. Johnson Matthey's Dr Butler suggests the demand for metal-based investments is growing but believes it's still a specialist investment. There's no typical profile of an investor, he says; there is a mix of institutions, managed funds and individuals all contributing to the vacillations the market might go through. Arnold concurs, it's good for hedging against more volatile stocks in times of uncertainty but the fund manager needs to know what he or she is doing and when he or she is wisest to get out.

It's clear that you can get it wrong severely even if you've more or less persuaded everyone your middle name is 'Prudence'. Gordon Brown was much derided during his 2010 election defeat, but he presided over a lot of apparent economic stability and high employment backed with low inflation. He didn't appear to be a stupid man but he was able to mistime the selling of some of our most precious assets - something that came back to haunt him.

As a non-specialist writer I can only say there's something comforting about the idea of investing in something, which, if you demanded it, you could actually touch. Many of the financial instruments blamed for the recession were pretty abstract; futures, essentially bets on how a company might perform in future, or hedge funds - when it collapsed a great many people said the economy needed to be based on actual stuff made by actual people rather than airy-fairy concepts.

This is why the retreat to gold and its foothills, the other precious metals, starts whenever the balloon goes up. It's entirely possible it'll go up again even after the current conditions have passed, and all the signs are that the metals will still be a good place to invest.

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