Conal Gregory: Gold splits investors but can be '˜a hedge against catastrophe'

America’s most successful professional investor, Warren Buffett, sees no value in owning the precious metal, claiming it will always underperform over the long term.

Unlike dividend-paying stocks or bonds which pay a yield, gold cannot compound over time.

Other investors take a contrary view, seeing gold as a ‘safe haven’, as a hedge against the end of the world or an insurance policy against central bankers making mistakes. In many cultures, gold is perceived to have inherent value. Many Indians treat it as a wedding gift and its world value will be boosted by India’s recent decision to reverse a policy of requiring ID for any purchases over 50,000 rupees.

Chelsea Financial Services do not agree that gold is ‘safe’ as the price and the shares based on it can be very volatile. Yet, says its chief executive, Darius McDermott: “We are in such an extraordinary and untested point in our history that, if central banks do get their timing wrong, having a small allocation in gold as part of a wider portfolio could be beneficial.”

Some of the fundamentals are certainly in place for gold to perform well. There is a continuing demand from sovereign nations, uncertainty surrounding much of the global economy and significant geopolitical risks whilst the outlook for other assets is very mixed.

Gold has often jumped around in price. From its peak in 1980, the price fell by 65 per cent in less than 30 months. It took over 28 years for the 1980 level to be reached again and investors to get their money back, not taking into account the effects of inflation.

Whilst the price of gold has risen this year, it is some way from its peak. It remains to be seen if this is a sustainable bounce-back or whether it will fall again. It reached over US$1,800 per troy ounce in 2011 but fell to around $1,100 early last year and now stands around $1,275. Gold therefore shows so wild fluctuations for a supposedly safe asset.

To gain the full diversification benefits of this asset, physical gold needs to be purchased. This can be achieved through websites like Bullion Vault, allowing as little as one gram of gold to be bought. Bars are available in a wide range of sizes and more commonly traded through specialist companies rather than over a bank counter. The gold is stored in vaults across the globe and it is important to check not only the custodian but also the ongoing service costs including insurance.

Sovereign coins are considered money and therefore free from capital gains tax.

Jewellery is one route but the timing to redeem it can be difficult. Investors need to factor in the significant mark-ups by the trade.

Chris Stevenson, director at Barclays Smart Investor, suggests that alternatively a physical gold exchange traded fund (or ETF) could be considered. These are traded like shares on a stock exchange and are normally fully backed by physical gold deposits.

The funds are designed to be a simple low cost means to access movements in the gold price with returns equivalent to such changes less charges. However, ETFs can encourage speculators and short-term trading on a rising price and then a substantial fall when the same investors bale out.

An ETF can be held in both an ISA and a SIPP. Jason Hollands from Tilney Investment Management, which advises Saga clients, suggests using Source Physical Gold P-ETC, which is London-listed and has an ongoing cost of only 0.29 per cent.

Gold shares or gold mining equities form a key route. However, be prepared for an exaggerated performance as when gold prices rise, equities based on the metal tend to increase at a faster rate and fall at a more severe pace when bullion prices drop. They may also be affected by other factors. Whilst gold shares have been very weak in recent years, falling by a much greater extent than the spot price, “this could provide an even more attractive opportunity should the gold price begin to rally”, says Martin Payne, Leeds-based director at wealth manager Brewin Dolphin.

Gold mining companies face serious challenges which add to the volatility. Foremost among these is the difficulty in accessing the metal, often now a mile underground, which raises production costs. At its current price, miners have problems operating profitably.

Payne likes Randgold Resources, which is in the FTSE100 and operates in Mali, the Ivory Coast and the Democratic Republic of the Congo. He says: “The management team is among the most highly regarded in the sector” and whilst the geopolitical risk is high by comparison with many other sectors, it is low when compared with UK-listed precious metals companies.

“The biggest risks for gold are likely to be a strong US dollar, less demand from India, China and central banks, coupled with world peace as gold is an asset people turn to in times of crisis,” says Kelly Kirby, chartered financial planner at Chase de Vere in Leeds. Ideally, gold investors look for a weaker dollar, economic uncertainty and geopolitical risk.

“Gold is a hedge against catastrophe,” claims Laith Khalaf, senior analyst at private client broker Hargreaves Lansdown. He suggests it should not form more than five to 10 per cent of overall investments.

Adrian Lowcock, investment director at Architas, says gold is a form of protection against both equities and inflation as the correlation is “fairly low” and suggests holding around five per cent as a long term diversifier. Lowcock says the gold price has not been performing better because of the health of the global economy, South Africa excepted.

Rather than selecting single mining firms, a more cautious investor would be better to take a fund where exposure is across a range of different gold companies. Two collectives favoured by McDermott are Elite-rated BlackRock Gold & General and Old Mutual Gold and Silver.

The former is the most widely known fund and invests in firms which derive their business from exploration, mining or production of gold.

Both Payne and Lowcock also like the BlackRock fund where the manager seeks mid and smaller sized firms with high earnings growth. Chris Price, investment specialist at Redmayne-Bentley, likes the fund as well as CF Ruffer Gold (over £700m with over 100 holdings including Evolution Mining and Kinross Gold) and Investec Global Gold (including the derivatives of gold mining firms). The latter is small at £90m with such shares as Goldcorp and Oceangold.

Kirby does not recommend buying gold as it does not produce any income, interest or dividends. She says many investors will have some exposure if they hold a balanced and diversified portfolio of investment funds.

Yet whether as an asset of choice in times of panic and faith if the financial system crumbles, many will continue to value gold as an insurance holding.