Return of the Midas touch

Gold funds have returned some two to three times this figure over the same period, as a result of the gearing of mining shares to the gold price. Consequently, gold funds rank as the best performing asset class over that period.

Confounding critics

Common wisdom is that gold is an expensive asset to store, has a negative yield and is only a hedge against the apocalypse. However, these arguments were destroyed in “Gibson’s Paradox and the Gold Standard”, written in 1988 by Lawrence Summers (late Secretary of the US Treasury and Harvard president) and Robert Barsky. They argued that the relative price of gold is driven by, and is the reciprocal of, the real rate of return from capital markets. Furthermore, this relationship has strengthened since gold was floated.

Dollar doldrums

The fundamentals for the dollar are weak, with foreigners owning more than $1,200bn of US treasuries. We continue to face an avalanche of alarming statistics: money supply has grown by over 74 per cent in the last 10 years, interest rates are at 50-year lows, saving rates are at record lows, and the US current account deficit is moving towards 7.0 per cent.

At the same time, the fundamentals for gold are continuing to improve significantly.

• Gold is the only tangible currency in the world – standing in sharp contrast to the dollar – an IOU from “Uncle Sam” backed by a flawed economy and the ever-present monetary printing press.
• China and India’s central banks have been increasing their gold reserves.
• Physical demand exceeds supply and this gap is growing. The supply deficit over the past decade has been met by central bank direct sales and leasing – and without this manipulation the price of gold would be substantially higher than it is today.
• Exploration and development was severely cut back in the 25-year bear market for gold – it takes anywhere between six and 10 years for a new gold mine to come online, hence increased demand cannot be met immediately.
• Recently, Chinese nationals have been allowed to own gold direct – this will lead to increased demand as the Chinese know all too well the implications of a devaluing currency.
• Russian money supply has increased by over 500 per cent in the last six years – with inflation lurking in the wings, local investors are being driven towards gold and tangible assets.
• Both the Middle East and China wish to diversify their reliance on the dollar and China in particular will eventually be forced to float its currency. Also a proposed new Middle Eastern Dinar backed by gold and the euro.
• Gold mining companies are no longer hedging their future sales of gold.
• The World Gold Council is soon to launch two exchange-traded funds (ETFs) in the US and UK that will facilitate gold investment.

Fundamental strength

Therefore, gold is an under-valued, under-owned and under-appreciated asset. Most investors also misunderstand it. At the beginning of the 1970s, when gold was about to undertake its historic move from $35 per ounce to $800 per ounce in the subsequent 10 years, the same observations would have been valid. The only difference perhaps is that the fundamentals actually look better.

There is strong evidence that we are in the very early stages of a secular gold bull market. The best way to take advantage of this is through gold funds and a portfolio allocation of up to 10 per cent.

At the time of writing the price of gold bullion was $380 per ounce.

Andy Whelan is executive director of Liberty Ermitage

‘There is strong evidence that we

are in the very early stages of a secular gold bull market’

Andy Whelan, Liberty Ermitage