Lowcock: Is gold becoming an income investment?

16 August 2012 | By Adrian Lowcock

Markets are counting on some sort of support or stimulus from the Federal Reserve and European Central bank to get growth back on track and avoid a default or collapse of the eurozone. However, politicians have demonstrated time and again that they will wait until the eleventh hour before they will act. Austerity measures and bank bailouts are unpopular with voting public so political leaders need proof that there really was no other choice.

This means we could see markets take another rout as we saw last summer and investors look to safe havens such as gold.

Last year, equity markets took a tumble in August as the US politicians wrangled over whether or not extend the debt ceiling and the eurozone crisis deepened. The FTSE 100 lost 870 points or close to 15 per cent from the start of August 2011 to 4 October 2011.

Gold, however, rallied at the start of the crisis/ sell-off rising $281 from August to September peaking at $1,900.05. However, the rally petered out and gold had pretty much lost all of its gains (gold bullion price on 4 October was $1619.92) by the time FTSE 100 bottomed out in October.

Because of the development of gold ETFs investors can access gold much more readily then they previously had been able to. So when markets started to fall active investors (including professional institutional investors) rapidly moved their assets into gold driving the price up quickly in the short term. However, this can also work in the opposite when markets start to fall even more sharply and investors become increasingly risk adverse and seek cash. Because of gold’s liquidity asset managers will sell that first and quickest.

So investors in gold need to be aware that the volatility of gold has increased (partly driven by increasing popularity of ETFs) and act quickly if they want to benefit from its safe haven characteristics.

Gold ETFs are a cheaper and more effective way to get exposure to the gold price. This sort of investment will provide investors with direct exposure to the gold price.

Gold miners used to be a good proxy for gold exposure but the increasing popularity of gold ETFs has resulted in gold equities becoming less correlated with the gold price.

From April 2011 this has become increasingly pronounced as gold bullion rose 16.16 per cent whilst the FTSE Gold Mines index lost 26.39 per cent. The knock on effect is that miners have become more equity like than previously, when equities sell off they partake.

In addition miners used to hedge the gold price which means they have not been able to benefit from the full rise in commodity prices. Since the beginning of 2012 gold miners (FTSE Gold Mines index) has fallen 22.68 per cent compared to FTSE 100 rising 1.88 per cent and gold bullion USD falling 1.59 per cent. However gold shares do look oversold and miners are taking action - Newmont Mining has started to payout dividends which is linked to the gold price.Starting at $1,000 they will pay $0.20 per share annually for each $100 they receive on the average price of gold they sell. We expect this trend to continue which means gold shares could prove an interesting investment opportunity as they get rerated as income payers.

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^{Adrian Lowcock is senior investment adviser at Bestinvest.}

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