Investing In Gold?

I have a lot of friends and clients asking me recently about whether they should put their
money into gold. Before I address that question, let’s talk about GOLD. For millennia, gold
has been a barometer of financial health and the ultimate store of value. It has long been
considered the ultimate safe haven investment when all else fails especially after this credit
crisis and global recession.

So now that gold has made a second big swing - shooting from $600 an ounce to $900 an
ounce after punching through the $1,000 plateau last year - is the “yellow metal” still a
prudent investment, or is it an investment that has already been played out?

Before the above question can be answered, let’s look at “GOLD 101”; the supply and
demand of gold which in turn determines its price. Talking about gold price, here is the
interesting fact about gold price

Gold price is

$252.80 on 20 July 1999

$255.95 on 2 April 2001 (Where the Bull Run Started)

$1,011.25 on 17 March 2008 (Peak of the Run)

$692.50 on 24 October 2008 (Price Hit By Credit Crisis)

$930.00 on 31 Jan 2009

$881.00 as I’m writing this article…

If you have noticed the sharp fall in gold price within a short span of 6 months from the peak
in March 2008 to the valley in October 2008, it is obvious that the huge fall in price was a
result of the credit crunch as investor cash out of gold amidst the fall in all other asset classes.

If we look at gold as compared to other commodities, I would consider it safer as it moves

independently. Gold is the only commodity with positive gain as compared to other
commodities in 2008.

There are a lot of factors affecting the demand and supply of gold. Some examples will be
that of the value of US dollar, political risks, inflation, new gold discoveries etc. Honestly,
there is no one single factor that can determine the demand and supply of gold in totality.

According to World Gold Council, Demand of gold from 2003-2007 are broken down as
follows:

Jewellery- 68% (2008 is 59%)

Industry Usage- 13% (2008 is 11%)

Investment- 19% (2008 is 30%)

The Supply of gold is as follows:

Recycled Gold- 25%

Mine Production- 60%

Net Central Bank Sale- 14%

It is to be noted that the net central bank sale on the supply side has been rather constant after
the incident in 1999 where the bank of UK sold 400 tonnes of gold which causes the plunge
in gold price in that same year. Since then, to prevent such drastic plunge in gold price, most
central banks have an agreement signed not to sell more than 400 tonnes of gold at one time.
The current agreement by all central bank is not to sell more than 500 tonnes of gold into the
market with the exception of the central bank of UK. Currently, all European central bank has
60% reserve in gold, except UK only 40% after the great sale in 1999 which it must have
regretted for many years to come…

Talking about the jewellery demand side of gold, there is no doubt that India is the highest,
followed by US (But it has went down in recent years) and then China ( China demand for
jewellery has doubled in last 5 years)

Demand of gold for industry usage has been rather consistent over the years, although it is
expected to dip a bit amidst this global recession.

What is worth an attention is the spike in demand of gold from the investment side. 30% of
total demand for gold in 2008 as compared to only about 19% in previous years. I believe this
figures will continue to rise in year 2009.

Switching our focus into the supply factors, there will always be people selling gold when
price starts to increase. Recycled gold percentage as a supply will tends to go up as price of
gold increases.

The good news is that Mine production for gold has been going down and this accounts for
60% supply of gold in the whole world. There is no new discovery for the past years as price
of gold then is low and gold mining is expensive. The bad news about this supply factor is
that as price of gold accelerates further, there is greater motivation for businessman to start
mining for gold again and hence increases the supply of gold as new mines are being
discovered.

Net central bank sale of gold had been rather consistent for the past few years with US
holding currently around $252 Billion worth of Gold Reserve

This brings us back to the big question: “Should I invest in gold ?”

With the above analysis, it is obvious that price of gold will go up as investment demand for
it increases in 2009. The counter effect on gold price will then comes from the increase in
recycled gold and new mining ventures following up.
With US Dollar likely to depreciate in the long run as mentioned in my second Blog and
inflation creeping higher in the future, Gold may be a good hedge against US dollar.

Therefore, gold is a necessary component of almost any portfolio. The problem is that the
iShares SPDR Gold Trust ETF already has accumulated more gold than the rich countries
of Switzerland or China. That means any move from the masses of investors to leave the
metal will have a huge downward effect on it.

But, knowing this important technical risk, I would still be ready to invest if gold pulls back
to the $750 an ounce level. From there, I’d keep building a prudent position not exceeding
10% of my portfolio, as we should see a price spike once inflation starts showing up in 12
months to 18 months. As inflation spikes up, be prepared to let go the gold at prices beyond
the $1,000 marks.

I hope you enjoy this discussion.

Talk to you again and do have a fantastic week ahead!

Sincere Appreciation,

Philip Chua, ChFC CFP FChFP

IARFC AMC B.BUS (Hons)

http://www.philipchua.com/

Twitter me @ phichua