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The Lolly beginners' guide to investing in gold

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Gold has been an amazing investment this century, beating the returns from shares, bonds and property. We look at why this is so.

by Gavin Lumsden on Jan 21, 2013 at 16:26

The Lolly beginners' guide to investing in gold

I visited the Albert Memorial, with its golden statue of Prince Albert, to talk about how demand for gold as a defence against inflation and as an alternative currency has been behind the soaring price of the precious metal.

This is the latest in The Lolly Investor Programme, a weekly series of videos explaining the basics of investment to beginners.

Hello, welcome to the Lolly Investment Programme beginners' guide to gold!

I've come to the Albert Memorial, which commemorates Prince Albert, husband of Queen Victoria who died in 1861.

This London landmark was made more striking by the decision in the 1990s to gild it in gold leaf.

I want to talk about gold because returns from the precious metal have easily beaten the returns from shares, bonds and property this century.

It’s a curious type of investment though, quite unlike those other asset classes, but plays an increasingly important part in investors' savings.

When I began this series a year ago I explained how income was a big driver of a lot of investment.

With interest rates stuck at an all-time low, investors' search for income has underlined the truth of an age-old rule.

This is that assets like shares, bonds and property are largely priced according to the income they yield, or are expected to produce.

Gold is the exception to that rule. There is no income to be had from a precious metal! Gold doesn't pay a dividend, interest or rent.

So what does it do?

The fact is gold doesn’t do a lot, but that’s its appeal.

Gold is widely used in electronics because of its conductive properties, but its main use has always been making jewellery and gold coins – and filling a few teeth!

And that’s because from ancient times until now gold has been associated with wealth.

But the bling factor isn't what excites investors.

Gold's investment significance lies in its impressive ability to store value.

Think about it. Treasures that were buried thousands of years are dug up and are worth even more today, in part because of the amazing craftsmanship and rarity of these artefacts, but partly because they are simply made of gold.

Investors love gold because its value is not eroded by inflation.

It’s also a tangible asset, which means if you own gold you can literally get your hands on it in a way that you can’t with stocks and shares.

That’s a big advantage if you’re worried about the stability of your bank or the financial system.

Property is also tangible, but who can put a house in their pocket in the way you can with gold coins?

The fact is gold is the ultimate defensive investment . When the brown stuff really hits the fan, and societies are crashing, never mind the stock markets, you want your wealth in gold.

As you can see from the chart the price of gold has soared in the 21st century, rising from under 300 dollars an ounce to nearly 1700 dollars today.

It really started to shoot up around the financial crisis in 2007 and 2008.

Although the banking system has stabilised, gold has continued to rise in response to the measures taken by central banks to prevent a depression.

Central banks like the US Federal Reserve and the Bank of England have effectively printed hundreds and billions of new dollars and pounds to reflate their economies after the bursting of the credit bubble.

Investors worry these ‘quantitative easing’ policies are hugely inflationary.

Many believe the Fed and the Bank of England are happy to let inflation rise to reduce the value of their countries’ massive debts.

Moreover, the US, UK and Japan seem to be engaged in a war to push down the value of their currencies. This is meant to help their exporters but it could also stoke inflation.

Gold’s appeal as a defence against inflation and as an alternative, purer currency has never been stronger.

So how do you buy gold?

Many professional portfolio managers put as much as 5% to 10% of their investors’ money in gold, so it’s an important consideration.

The easiest way for investors to get gold exposure is to buy an exchange traded fund tracking the gold price.

There are also actively managed funds which invest in gold and in gold mining companies.

However, with gold funds you own units or shares in the fund, not the gold itself.

If you actually want to own gold, there are specialist firms that will sell you gold coins and bars. This is the purest way of investing in gold, although the costs of storage are an issue to consider.

The big debate around gold is where it will go next?

Gold’s remarkable gains have slowed of late. It rose modestly last year as confidence returned to stock markets and the eurozone debt crisis subsided.

It’s possible gold will have a similar year in 2013 but after that could rise a lot more if inflation becomes a problem.

14 comments so far. Why not have your say?

Philmo

Jan 21, 2013 at 18:03

Gold has increaqsingly shown its mettle as people have become savvy to just how rotten are the synthetic products devised by governments and banks etc

Especially ones from the US!!!!

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nicholas gold

Jan 21, 2013 at 19:03

ETF investments are only as safe as the integrity of the metal backing them, and unfortunately, the paper is certainly not worth its weight in gold, silver, or even copper. Right now any relation between GLD, SLV, and reality is remote indeed. Physical metal purchases, despite minor inconveniences of storage, safety, and so on, are still to be preferred over the risks of ETF instruments.

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Zaydac

Jan 21, 2013 at 21:49

Lumsden says that 'the value of gold is not eroded by inflation' but there have been periods of significant inflation when gold has not gone up in price. Erb & Harvey (1) have shown pretty convincingly that there is 'little evidence that gold has been an effective hedge against unexpected inflation whether measured in the short term or the long term', and 'there is no reason to expect that the real gold return will be positive when a specific country experiences hyperinflation'. In fact during 2009 - 2011 the gold price rose during a period which was as close to deflation as we have seen since the 1930s!

Also Lumsden didn't mention that if (contrary to past experience) gold does rise with inflation CGT will wipe out a lot of real wealth, unless you buy UK currency coins which are exempt from CGT, he didn't mention the tungsten problem, and he didn't mention BullionVault or GoldMoney, two highly reputable ways of buying and trading gold.

Lumsden was, I think, trying to explain why one might buy gold. For a really good explanation I suggest John Mauldin's recent article 'Central Bank insurance' (2).

(1) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2078535 - download the pdf

(2) http://www.mauldineconomics.com/frontlinethoughts/central-bank-insurance1#bitten

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ynys

Jan 22, 2013 at 01:40

Oh no! Not more BS about gold

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J Thomas

Jan 22, 2013 at 15:18

Treat gold as an interesting hobby collecting Sovereigns and Guineas and you wont go far wrong.

The gold price is impossible to predict, even more so than the stock market. If gold rises you will make good money, however if it falls you will still have your beautiful historical coins to admire.

However you only borrow these, they will be owned by other collectors/investors in a thousand years.

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Anonymous 1 needed this 'off the record'

Jan 23, 2013 at 11:12

This is all based on hindsight. It's a major reason why most investors lose money. He's basically telling people to invest in gold cos it's performed well in the recent past.

Gold has done well so far this century but it's a volatile single commodity and is capable of experiencing massive drawdowns. There are lots of very convincing sounding fundamental arguments as to why gold will end up at $5000 an oz but then again, I could just as easily accept gold being priced at $300 again. It's just a number and the only truth is in the price. Calling it the "ultimate defensive investment" is frankly just not true.

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fred the shred

Jan 23, 2013 at 14:50

gold is always a gamble

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Philmo

Jan 23, 2013 at 21:29

That can't, surely, be THE fred the shred - who took a huge gamble on Ambro, and lost big-time?

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Barry Read

Jan 25, 2013 at 10:16

Is it the right time to invest in gold? Traditionally it has always been a safe investment during an economic crisis and always retains or goes up in value. However, with all the issues around German gold at the moment it may not be as safe an investment as it has been traditionally. This is an interesting report on the matter http://bit.ly/WYh7xd

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John Minard

Jan 27, 2013 at 09:18

it's a finite resource, and there's more demand for it than ever.

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Anonymous 1 needed this 'off the record'

Jan 27, 2013 at 13:49

So is land John. Does that mean it will be a straight line up?

Predictions related to any financial instrument are utterly pointless

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John Minard

Jan 27, 2013 at 14:28

no, it's not likely to be a 'straight line' - what is?

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Steve K

Jan 28, 2013 at 10:53

Fundamentally, you have to take a view of whether you believe the financial crisis is waning or just beginning. Since I cannot see where any Western government has done anything other than sweep the core problems deeper under the rug (see: "Fiscal Cliff Part II" coming soon to theatre near you), having exposure to gold (even if only as an insurance policy) is a must. And holding in physical but liquid form (e.g. via the aforementioned BullionVault) even better.

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rik

Jan 30, 2013 at 22:41

You can't eat it.

It provides no income.

It gets stolen.

Whats not to like about gold?

Rik

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