Should you include gold in your portfolio?

2015-01-21 17:25

Ever wondered why you should consider including gold in an investment portfolio?

Gold is a very strong portfolio diversifier: historically, gold has shown itself to be very poorly correlated with almost all other assets like shares, interest rates etc.

Diversification must be the oldest and most effective of all risk management strategies. This is achieved by combining different, uncorrelated assets in a portfolio. What it does is that it makes sure that one’s portfolio returns don’t show excessive variability – also called volatility. The latter is undesirable, especially when there might be a need to partially liquidate it.

Gold provides catastrophe insurance. It is arguably the world’s oldest store of value. Since the start of civilisation, humans have trusted the yellow metal as a way to protect savings and accumulated wealth. Especially in times of financial system distress like inflation, or equity market turmoil, gold holds it value. Since gold’s value derives from its intrinsic worth, it is completely independent of the stability or health of the financial system for its value. For this reason, many investors keep a portion of their portfolios in gold – as a form of turmoil and disaster insurance.

And, it’s the ultimate liquidity. It is recognised globally as a means of exchange and a store of value.

It is fully exchangeable in almost any country for goods, services of local currency. This is a very powerful characteristic.

Furthermore, due to its indestructability, gold makes for a very good medium of wealth transfer. This means that paper currency is easily destroyed by water or fire, or even animals. Gold on the other hand does not tarnish or rust, nor will it go up in smoke.

Given the above, many investment advisors recommend a gold holding of 5 to 10% of a portfolio’s value. This is independent of the price of gold as the properties sought are not determined by the entry price.

There are many ways in which one can gain exposure to the gold price: jewellery, gold medallions or collectible coins, Krugerrands or via an Exchange Traded Fund (ETF) on the JSE. These are all quite different when it comes to investment efficiency:

Financial instruments that provide direct exposure to the gold price, like ETFs or unit trusts carry management fees. This can, in time, and especially in a rising gold price environment significantly erode the investment gains.

Jewellery on the other hand, typically trades at substantial premia to the intrinsic gold value – in many instances up to 10 fold.

In other words, when buying a piece for R2000, the gold content could only be R200. As such, jewellery is a very inefficient way to gain exposure to the gold price.

Collectible coins or medallions like the Mandela commemorative coin generally trade at a significant numismatic premium. What this means is that, as with jewellery, the actual value of the gold contained in these coins, constitute only a small portion of the total value – generally 50% or less. Under a fire-sale, one typically would only receive the bullion value, meaning that a substantial loss could be made – even if the gold price had gone up.

Furthermore, the collectible nature of rare coins makes them quite hard to liquidate at a price that includes a good part of the numismatic premium initially paid. Thus, all in all, for an investor that wants to gain exposure to the gold price, rare or collectible coins are relatively inefficient entry points.

Krugerrands are often referred to as bullion coins. This means that they are not really collectible in their own right. Rather, they are looked at as ways to gain exposure to the gold price only.

As such, these coins trade at prices very close to the value of the contained bullion; in fact, the value of a Kruger rand is more than 96% determined by the gold content (when bought via the FNB Share Investing platform). (Not all coin dealers sell at the same premium with many loading the price with as much as 15 to 20% above the value of the contained bullion.)

Moreover, they are very liquid instruments: Krugerrands being bullion currency are almost fully fungible – the year of minting plays no role in a coin’s value.

The above shows that Krugerrands are arguably the most cost efficient and direct way to gain exposure to the gold price. The fact that the coins are zero rated for VAT, whilst jewellery and other coins or medallions are not, makes them even more efficient.

You can buy & sell Krugerrands online through FNB Share Investing. What’s more, FNB can also store your coins and will guarantee to buy them back.

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