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Investment Ideas

Most investors either love or hate gold as an investment asset but the fact remains that gold has been able to protect its real value for a very long period of time.

The precious metal has now been on a bull run for more than 11 years and many investors fear that it may be in a bubble but there are others who defend the rise in gold price as a natural response to massive money creation by the governments all over the world.

On the other hand, gold’s detractors say gold is more like a speculative asset rather than an investment asset as it does not generate any income and there is no way to assess its “fair price”. (Read: Three ETFs to Prepare for the Fiscal Cliff)

Gold had a nice pop after the QE3 announcement but has since come down to its pre-QE3 announcement level. But in case the Euro-zone crisis escalates, gold prices will get further boost.

Some of the investment banks have recently raised their price target for gold. Deutsche Bank says gold prices would reach $2,000 per ounce in the first half of 2013, while BOA-Merrill Lynch predicts gold would touch $2,400 by the end of 2014. (Read: QE3 and Mortgage REIT ETFs s Winning Combo?)

Investment Case for Gold

1) Inflation Hedge and Store of Value

As the major central banks all over the world continue to increase money supply, the investment case for gold becomes stronger. (Read Obama or Romney? Win with these ETFs)

In his latest Investment Outlook, Bill Gross the founder of PIMCO warned that  US debt problems have put the country in this “ring of fire”, as a result of which “Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets would survive.

Even with bull-run lasting more than a decade, the inflation adjusted prices are still below the highs reached in the 1980s.

 

2) Official Sector Gold Purchases Are Going Up

Central banks all over the world have been adding to their reserves, according to the data available from the IMF.  Of late, the addition to the gold reserves has been mainly due to lack of other “safe” investment alternatives. According to IMF, the supply of “safe” assets has been dwindling while their demand will go up in future, increasing the price of “safety”.

During the second quarter this year official gold reserves were up by 157.5 tonnes, representing the largest quarterly purchases since the central banks became net buyer of the metal in the second quarter of 2009.

At present, most of official sector gold is held by the developed countries (mainly as a gold standard legacy), whereas while emerging nations have been accumulating significant amount of foreign exchange reserves, they still hold relatively little proportion of gold. For example, Brazil has just 0.5% of its reserves in gold; China has less than 2%, while Russia and India have about 10% of their reserves in gold. The following table shows the gold holdings of central banks as a percent of total reserves. 

Top 5 Countries By Gold Holdings

Top 5 Countries by Forex Reserves

USA

75.4%

China

1.7%

Germany

72.4%

Japan

3.2%

Italy

72.0%

Saudi Arabia

2.8%

France

71.6%

Russia

9.6%

China

1.7%

Taiwan

5.7%

If the emerging countries flush with billions of dollars of foreign exchange reserves continue to increase their gold holdings, the metal price will continue to find a solid support.

3) Rising Demand from China and India

Over the last decade the demand for gold in the emerging countries has been rising. The demand from India and China is expected to grow as the middle class in these countries prefer gold as a store of value. The consumers in these two countries account for about 45% of annual global gold consumption.

Expanding middle class in these countries and their growing spending power will continue to generate a significant proportion of gold’s worldwide consumer demand.

This year gold demand in these countries had suffered due to economic slowdown in China and India but the consumer demand will go up again when these economies improve. Additionally, the demand in India has also been affected due to the jump in gold price resulting from the decline of the Indian rupee against the US Dollar. In Indian rupee terms, gold prices are at all time high.

However, the demand for gold may go up in the next few months in these two countries due to beginning of festival and wedding season in India and then the Chinese lunar year.

4) Global Supply of Gold Stagnant

Though gold prices have been going up in the past decade, global mine production has not increased much during the same period and is also likely to stay stagnant in the coming years. Per World Gold Council, supply from mine production has averaged approximately 2,602.2 tonnes per year over the last five years. During the second quarter of 2012, supply of gold contracted 6% year-on-year. 

5) Portfolio Diversification

Over longer period, gold has shown very low correlations with most other assets. Given its diversification potential, gold should be a small part (5% to 10%) of any investment portfolio.

Physically backed gold ETFs are the most convenient, low-cost and effective way to invest in the metal.

 

 

GLD

IAU

SGOL

Inception Date

11/18/2004

01/21/2005

09/09/2009

AUM (million)

$74.8 billion

$11.6 billion

$2.0 billion

Average Daily Volume

2.5 million

1.6 million

8.5 thousand

Expense Ratio

0.40%

0.25%

0.39%

YTD Return

10.8%

11.0%

10.6%

SPDR Gold Trust (GLD)
GLD is the largest, most liquid and widely traded gold ETF. It seeks to replicate the performance of the gold bullion and each share represents 1/10th of an ounce of gold. The fund is backed by physical holding of gold bullion in London vaults.

iShares Gold Trust (IAU)
IAU presents a much cheaper option to GLD with its expense ratio at 0.25% per year. Each share of IAU represents about 1/100th of an ounce of bullion. The shares are backed by gold, held by the custodian in vaults in the vicinity of New York, Toronto, London and other locations.

Though more expensive, GLD holds more than six times in assets (resulting in higher liquidity), trades in higher volumes and has slightly lower bid-ask spreads, which may result in some benefit for very large trades. But for most retail investors, IAU is a more cost-effective option.

ETFS Physical Swiss Gold Shares (SGOL)
SGOL’s main selling point is that its gold bullion is held in the vaults of Zurich, Switzerland. Like GLD, each share of SGOL represents 1/10th of an ounce of gold. But compared to GLD and IAU, it is much less liquid, which may be reflected in high bid-ask ratio. With an expense ratio of 0.39% per year, SGOL does not offer any cost advantage also. So, unless you are worried about any risk to the safely of gold held in New York or London vaults, there is no reason to prefer SGOL over the other two.

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