28 October 2016
With the monetary system on a shaky ground, investors can only count on gold to protect their wealth. Photo: HKEJ
With the monetary system on a shaky ground, investors can only count on gold to protect their wealth. Photo: HKEJ

Cheap gold offers a chance to build or expand portfolios

Gold prices tumbled to a five-year low on Tuesday and struggled to stay above US$1,000 per ounce.

The yellow metal slumped nearly US$45 within three minutes of the opening and dropped to US$1,086 during the Asia morning trade.

It remains unclear whether big fund managers were behind the sell-off. Japan was closed for a holiday.

China’s A shares have slumped by 30 percent in the past three weeks.

By contrast, gold has slid 42 percent to US$1,106 per ounce from a peak of US$1,921 in September 2011.

The market has taken as long as four years to lose that much.

The gold market has always been flooded with conspiracy theories but we’ve also heard about factors that support prices.

Central banks have been printing excess money to bolster economic growth, stoking inflation.

The monetary system is on a shaky ground and investors can only count on gold to protect their wealth.

Meanwhile, the world continues to grapple with geo-political crises.

Despite robust demand from India and China, gold accounts for a small proportion of holdings by institutional investors.

The media sees a battle between money-printing central banks and superhero gold investors.

Gold decoupled from major currencies when the gold standard ended.

Unlike stocks or bonds, gold has no objective valuation and investors can’t collect any interest from holding gold.

Price appreciation is the biggest incentive for gold investors apart from its appeal as a safe haven and a hedge against inflation.

Gold prices have surged 6.5 times during the past 10 years to a peak of US$1,921 in 2011 from a trough of US$256 in 2001.

Investors and speculators make money from that cycle.

Some scholars compare the army salary payment under the first Roman emperor Augustus and the system in the US army today.

Using gold a s a benchmark, salaries have remained unchanged for 2,000 years.

Today, a US soldier has an annual salary equivalent to 38.9 ounces of gold, exactly the same as his Roman counterpart.

The comparison reflects the fact that gold prices have risen in line with salary growth, which usually exceeds consumer price growth due to improving productivity.

Gold has been proven to preserve wealth but it may not be a good investment.

Research shows that gold had a real annual growth rate of 1.1 percent between 1836 and 2011 after adjusting inflation.

That barely beats the 1 percent yield on short-term US government bonds but lags the 2.9 percent return on long-duration bonds and a 7.4 percent return from equities.

There are various reasons for the run-up in gold prices. Similarly, there are plenty of factors for a price decline.

China has not bought as much gold as the market expected and the US is set to hike the interest rates this summer.

The Greek debt crisis has been settled for the time being and Iran has reached a nuclear agreement with the West.

And US stocks have been hitting new highs.

Nevertheless, gold has a very low co-relation to stocks and bonds, so a small amount of gold investment can offer good diversification.

Investors should buy gold stocks while they’re cheap to build a portfolio or diversify existing holdings.

This article appeared in the Hong Kong Economic Journal on July 22.

Translation by Julie Zhu

[Chinese version中文版]

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Columnist at the Hong Kong Economic Journal

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