Welcome to Finance and Fury, the Say What Wednesday edition. This week’s question comes from Mario

“Loving the podcast on the central banks. I have a question about purchasing gold as part of my investment strategy. My core investment strategy is to invest in high quality stocks that pay a consistent and growing dividend however recently I feel that gold and silver as a hard asset are important. I know Warren Buffet advocates against the purchase of gold given its an unproductive asset and doesn’t generate income. I like the idea of having a hard asset that is tangible and acts in direct contrast to my equity portfolio however I know this may come at the opportunity costs of income and growth generated from equities.

Do you think holding physical gold or gold in an ETF is a good idea? Why or Why not? Would love to hear your views. “

 

Today – how gold works in a portfolio for capital preservation – methods of buying it and look at performances in portfolios

  1. Allocation as a hedge for a financial meltdown – should preserve capital, withstand market volatility, and provide diversification across a portfolio
  2. Gold and silver – an asset which is virtually permanent, with no significant erosion of quality over time, could arguably be considered a safe haven – good evidence that Gold has provided hedge again collapse – limited supply at about 1.5% p.a. increase

What is Gold true role – Capital preservation – but also Money – Base money for most of history – 1912 when J.P. Morgan was called to testify before Congress.

  1. Congressman – I want to ask you a few questions bearing on the subject that you have touched upon this morning, as to the control of money. The control of credit involves a control of money, does it not?
  2. JP – A control of credit? No. – Congressman: But the basis of banking is credit, is it not?
  3. JP – Not always. That [credit] is an evidence of banking, but it [credit] is not the money itself. Money is gold, and nothing else.
  4. This is very interesting – our money now is credit – Fiat – not backed by gold

This is Why people buy Gold – protect from these outcomes

  1. Also has many other uses including jewellery, electronics, dentistry, medical and other industrial use – and of course investment.
    1. Jewellery is the single-largest individual source of demand –
    2. 40% is investment purposes – bars, central bank reserves, ETFs
  2. Reasons for buying gold – Seen as safe haven when economy tanks
    1. fear of an economic crisis or inflation outbreak fuelling public demand;
      1. Gold has historically served as a hedge against a declining US dollar and rising inflation
      2. price of gold often moves in the opposite direction to the US dollar – reflecting the fact that many regard the yellow metal as an alternative currency
    2. a change in the sovereign wealth funds asset composition, such as demand from China, to diversify their holdings; and
    3. negative bond yields losing their appeal as an effective hedge against equities.
      1. If Aus starts QE – gold goes well
    4. Financial System – “Race to the bottom” fuels global demand for gold

Why is gold and silver good?

  1. Limited supply – Paper money today has potentially unlimited supply – at the Central Banks discretion
    1. Government has debt in the trillions, Australia, the UK and most of Asia (other than China) are all up to their eyeballs in debt
      1. Came from getting the money printed by issuing a debt instrument (bond) for the cash – but they also have to pay the interest back as well
    2. Over printing creates pressure on the currency, increasing volatility.
    3. Demand – If people buy gold, the price goes up
    4. Supply is limited – you have to actually go and find the metals, and get them out of the ground, there are not many new sites being found. This is why they are considered ‘inflation proof’, retaining real value compared to fiat currency

How to gain exposure – 3 major ways

  1. Gold ETFs – Through ASX – Few to choose from
    1. Gain exposure to gold pricing – buy ETF share, then represents an ownership in gold -not same as direct
    2. This works to hedge a portfolio based around price movement – easiest way to gain exposure to gold/precious metals –
  2. Physical Gold – done through dealers or private companies
    1. Storage – Hiding it under the mattress or arrange for secure storage – comes with its own associated costs
    2. Bonus of this – hold an asset you can store outside of the banking system with a private company
      1. Best way to preserve wealth during times of financial turmoil.
    3. holding physical bullion risky—and it can be – stolen or even melt in a house fire – requires adequate insurance
      1. can purchase and store physical gold bullion using automated platforms 
    4. Gold mining companies/ETFs
      1. Another way of getting exposure is to invest in listed companies with exposure to gold.
        Australian-listed companies include large, long-life gold miner Newcrest Mining (ASX: NCM), and mid-size gold producer Regis Resources (ASX: RRL) – both of which currently screen as overvalued by Morningstar senior equity analyst Mathew Hodge.
      2. Unlike other vehicles, stocks can provide a dividend income, but naturally introduce other variables, including the quality of the mine life, the cost of getting the metal out of the ground, company earnings and other balance sheet considerations.
    1. With one trade on ASX GDX (VanEck) gives investors instant access to 44 of the largest and most liquid global gold mining companies.
  1. GDX is the world’s largest gold miners ETF with around A$15 billion in assets under management.

Downsides – the opportunity costs to the portfolio –

  1. Gold itself as an asset class – not an income producing assets – but this is due to no counter party risk
    1. Cash – held in banks – pays interest –
    2. Income returns can pick up total returns on shares or property if the growth is low or negative
    3. Return solely based on demand
  2. Only Growth returns…which is hard to predict
    1. Too much diversification can hurt long term growth
  3. Physical gold downside – Costs for bullion storage
  4. ETFs downside – Counterparty risks at many levels – talked about this in previous ep – crisis assets
    1. Counterparty risk is present when another party in an agreement can default or fail to live up to their obligations
    2. Gold is meant to provide protection in collapse – but what if banks are collapsing – they are the counterparty
    3. Example – Buy ETF and gain exposure to the price of gold – Buying ETF through a large financial institution
      1. responsible for obtaining the underlying assets necessary to create ETF shares – Gold
      2. purchase gold as a trustee – then this trustee uses a custodian to source and store this – Custodian major counterparty – trustee is minor counter party
    4. If you buy gold as portfolio insurance against a systemic failure in the financial system – ETFs are intertwined with the world’s largest banks – doesn’t fit purpose well
      1. HSBC is the custodian for most ETFs in Gold – HSBC use sub-custodians, such as the Bank of England, to source and store gold. So, in addition to carrying custodian risk, investors also have sub-custodian risk.
    5. Technically – you are a shareholder of the Trust – access gold pricing – paper claim to gold
      1. The real irony is the price of gold could be skyrocketing and the ETFs could be going bankrupt at the same time.
    6. As such – if you are worried about a collapse of the financial system – direct gold better –
    7. If it’s in ETF form, good luck getting your gold! It’s all electronic through derivatives

How does it look in a portfolio

Van Aus, Van Int and Gold – returns ending 30 June – total returns

Allocation

6 Months

1 Year

3 Years

5 Years

7 Years

10 Years

Volatility

40 40 20

-1.69

4.80

10.06

8.73

10.60

9.53

15%

45 45 10

-4.23

1.88

9.12

8.30

10.51

9.87

17.5%

50 50 0

-6.78

-1.04

8.13

7.82

10.38

10.16

20%

 

Whilst they are very separate assets to each other, they work in a similar way. There has been increased volatility with shares in recent months, and this has led to an increase in gold and silver prices. They are considered an alternative growth investment; when other asset classes like shares, property and even bonds are doing badly, gold and silver are considered a “safer” way to invest.

Where it fits into a portfolio

  1. Growth allocation – Mainly as a capital hedge
  2. Constructing a portfolio, it might be suitable to allocate 5% – 15% or so into gold, but that doesn’t mean it’s right for everyone

In summary – It’s good as a long-term inflation hedge, and to diversify a portfolio out further, but can be volatile or non-performing (due to no income)

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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