June 1, 2010 3:07 pm

Q&A: Investing in gold

Q&A: James Turk at Gold Money

The gold price has hit a new all-time high in sterling terms following concerns about the strength of the coalition government in Britain and the debt crisis in Europe.

Gold reached £773 an ounce in recent weeks, a rise of around 25 per cent over the past year, and there has been little let-up in demand for the precious metal from investors since the start of the year.

If you’re looking for a safe haven for your assets and are interested in putting your money into gold but don’t know how to do it, or want to know what experts think will happen to the price in coming months, then send your questions in to be answered by an expert.

James Turk, founder and chairman of Gold Money, answers questions on how to invest in gold and what could happen to the price in the coming months

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What are the benefits of investing in physical gold? Marion, Madrid

James Turk: I don’t use the term “investing”, because gold is money. One does not ‘invest’ in money; one simply holds money until they are ready to use it to purchase a consumer good or to make an investment. By holding gold, you have money that is not dependent upon the promise of some bank or government. Gold is the only money without counterparty risk.

Importantly, even though it has done exceptionally well this decade, gold is still relatively undervalued, based on my valuation measures. The following table presents the rate of appreciation that gold has achieved this decade against nine of the world’s major currencies.

  USD AUD CAD CNY EUR INR JPY CHF GBP
 2001 2.50% 11.30% 8.80% 2.50% 8.10% 5.80% 17.40% 5.00% 5.40%
 2002 24.70% 13.50% 23.70% 24.80% 5.90% 24.00% 13.00% 3.90% 12.70%
 2003 19.60% -10.50% -2.20% 19.50% -0.50% 13.50% 7.90% 7.00% 7.90%
 2004 5.20% 1.40% -2.00% 5.20% -2.10% 0.00% 0.90% -3.00% -2.00%
 2005 18.20% 25.60% 14.50% 15.20% 35.10% 22.80% 35.70% 36.20% 31.80%
 2006 22.80% 14.40% 22.80% 18.80% 10.20% 20.50% 24.00% 13.90% 7.80%
 2007 31.40% 18.10% 11.50% 22.90% 18.80% 17.40% 23.40% 22.10% 29.70%
 2008 5.80% 33.00% 31.10% -1.00% 11.00% 30.50% -14.0% -0.30% 43.70%
 2009 23.90% -3.60% 5.90% 24.00% 20.40% 18.40% 27.10% 20.30% 12.10%
Aver 17.10% 11.50% 12.70% 14.70% 11.90% 17.00% 15.00% 11.70% 16.60%

Gold has appreciated at double-digits rates against all of these currencies, but an ounce of gold still purchases the same amount of crude oil it did back at the beginning of this decade. This observation is sobering because it shows how much purchasing power one has lost holding any currency this decade instead of gold. Even when factoring in the interest rate one earns for taking the risk of holding a currency, you are still better off owning gold.

Note too that I am comparing gold in this table to what it should be compared against, namely, other monies. Gold has been the best money to hold this decade.

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How can I invest in gold and where can I purchase gold for investment. What will be its value be in the coming months? Varsha, London

A few challenges in the way of gold investing are - 1.Storage 2.Wide bid-ask spread 3.Very difficult to find the outlet with the best price for a retail investor. What are your ideas towards clearing these roadblocks? Kapil Bidawatka, New York

JT: The objective of course should be to get the most physical gold for your money. In this regard, the Internet has been a boon to gold buyers because it makes the process of buying gold much simpler. For example, goldprice.org provides an up-to-date comparison of the live price of several dealers so you can easily shop and compare:

http://www.goldprice.org/gold-prices/

Don’t just focus on price though. While it is indeed important, service and reliability are also important considerations when you are buying. Look for established companies with solid reputations, and again, use the Internet as a resource.

Regarding storage, there are only two alternatives – self storage or professional storage. Each has advantages and disadvantages, so you have to weigh these up. For example, if you store at home the gold you purchase, you have it at hand. But how much gold are you willing to risk in this way from possible theft? And what is the cost of insurance, if you can even get it? When using professional storage, you don’t have your gold at hand, but it is safe when stored and insured in a specialised bullion vault.

In this regard, make sure your gold is in allocated, not unallocated storage. These terms are defined on the London Bullion Market Association’s website at the following link:

http://www.lbma.org.uk/london/glossary

But basically, allocated gold is physical metal that you own that is being stored for you in your name, so that your gold is distinguished from other gold stored in the vault.

The cost of professional storage need not be exorbitant. For example, at GoldMoney, the annual storage fee ranges from 0.15% to 0.18% and that includes insurance and regular audits conducted for our customers by two independent third-party firms. These firms are specialists that actually go into the three bullion vaults that our customers use to verify that the weight of gold, silver and platinum in these vaults equals the quantity of these metals owned by our customers. These audits are available to our customers when they login to their Holding.

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Hi James, I have been looking into getting into gold for quite some time, but I have been unsure what form to buy in. Some say historic coins, some say bars, while others say ETF’s or options. Which gives the fairest track of the gold price, has the lowest commission percentage and how can I mitigate the currency risk, as most valuations are based in US dollars. Kind regards Mark Raw ACCA, Bristol

JT: Historic coins have numismatic value, which means the price of a coin can far exceed the value of its precious metal content. These coins are investments; they are not money like bullion coins, the value of which comes solely from their bullion content. ETFs, options, futures and other derivatives are ways to speculate on the gold price. Consequently, they are fundamentally different than owning physical gold. Again, I recommend using the Internet as a resource to help you decide what and where to buy.

It is true that most dealers quote prices in terms of US dollars. Gold in this regard is like many financial instruments in that the US dollar is the preferred currency for market-making. So if you are not dollar-based, there may be a small cost converting from local currency to US dollars, even when you use your national currency to purchase from a local dealer. He will simply pass on to you the foreign exchange transaction cost for the dollars he needs to purchase the inventory that he sells to you.

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Hi James, I’ve made some small investments in Gold bullion already. Is it possible to convert my personal pension into a SIPP pension of gold bullion? Thanks a lot Conor McKenna, Belfast

JT: Yes, it is possible to hold gold bullion in a SIPP. More information is available at the following link:

http://goldmoney.com/gold-sipp.html

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Would a safer bet be to purchase a fund in precious metals and if so can you recommend a secure one? Many thanks Redmond Walsh, Brentwood Essex uk

JT: In my view, the safest choice is to own physical metal, rather than a fund. When you own a fund, you own a financial asset that comes with counterparty risk, which can only be avoided by owning a tangible asset. Because of the uncertainties surrounding the ongoing financial crisis, counterparty risk should be avoided, and I therefore recommend owning physical metal. But sometimes it is necessary to own a fund. For example, a tax-deferred pension plan may not allow physical gold, but would probably allow the purchase of a fund owning physical gold.

When physical metal cannot be purchased, two funds that I am familiar with and regularly recommend are Central Fund of Canada (CEF) and Sprott Physical Gold Fund (PHYS). Both are listed on Canadian and US exchanges.

I do not recommend the exchange traded funds, even though they have become popular in recent years. The biggest is GLD, which is listed in New York. The prospectus states its objective is to track the price of gold, which differs from the stated objective of the two funds mentioned above to own physical metal.

My point is that when you own exchange traded funds designed to track the gold price, you do not own gold; you only own exposure to the gold price. That makes GLD suitable for traders and speculators, but I do not recommend speculating. Buy gold if it is useful to you, and if so, buy physical gold, not its paper representations.

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How do you value gold? The conventional view seems to be that you can’t, because it has no yield. So why do conventional central banks even hold it? Roger Strange,

JT Value always comes from a thing’s usefulness. Gold has value because it is money, namely, it is useful for calculating prices of goods and services. Gold also preserves purchasing power over long periods of time. Being a tangible asset, gold achieves these results without any counterparty risk. In other words, gold is the only money that is not someone’s liability, which is particularly important today given all the uncertainty surrounding the ongoing financial crisis. So gold has value because it is useful, and importantly, gold is undervalued.

I use a number of measures to determine gold’s relative value, but the most important is a model I developed back in the 1980s called the Fear Index. Basically, it compares the market value of a country’s gold stock to the quantity of that country’s national currency expressed in M3, a broad definition of the quantity of money. For example, the Fear Index for the US dollar is only 2.1%, which is historically very low. The Fear Index reached 10% in 1980 and was over 30% in the 1930s.

Central banks hold gold because money is power, and gold is the most powerful money of all because it is not anyone’s liability. It is the only money that cannot be created out of thin air, so it cannot be debased by governments. If the present monetary system of circulating currencies that are not backed by anything eventually collapses, a new monetary system can be built upon gold.

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Journalists who claim that gold has hit a new all-time high in Sterling terms are probably suffering from Keynes’s money illusion. In today’s money (adjusting for inflation with CPI), an ounce of gold cost over 1000 at the peak of the last bubble in 1980, and if you’d bought such an ounce then you would have been sitting on a real-terms loss ever since. Why then should anybody believe that diving into another speculative mania now will present a good long-term investment? Lemondy Smith, London

JT: Based on my experience and recollections from the late-1980s, I can safely say that gold is not in a “speculative mania”. Relatively few people own gold, are interested in it, or are aware of how well gold has done this decade. We are only in the second stage of gold’s bull market. The first stage, which is marked by apathy and neglect ended when gold crossed above $1000 per ounce. That event brought attention to the fact that the gold price was rising, which ushered in the present second stage as people start learning and buying gold. The third stage is when speculation starts to drive the price, or as the old saying from Wall Street goes, when shoe-shine boys tell you to buy gold. The third stage is still far into the future.

Regarding the inflation adjustment of prices, it is worth noting that in the United States, for example, the CPI calculator used to measure prices today is different from that used when gold reached its last peak in January 1980. If the $850 price reached at that time were inflation adjusted with the same CPI calculator used back then, the inflation-adjusted gold price today would be $7400, according to John William of ShadowStats.com http://www.shadowstats.com/

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Dear sir, I am from southern part of India. I do real estate business, I have read your book and have received your commentary for the last four years. Will this on going crisis affect India, if dollar is losing value against Indian rupee then in the future will gold become cheap against indian rupee. Should we now invest in gold or not? Regards, Sathishnagaraj, salem, India

JT: All countries of the world are being impacted to some extent by the ongoing financial crisis. And everyone I believe should own some gold to protect themselves from the uncertainty as to how this crisis will unfold in the future. Gold is the ultimate safe haven because physical gold is money without any counterparty risk. So gold should be purchased for that reason. It is gold’s value that is important, not its price, which can fluctuate for a variety of different reasons.

For this reason, I don’t recommend trading gold. Leave that to professional traders and speculators. Buy gold because it is still undervalued, even though it has done as well as it has this decade. Accumulate gold. View gold to be your savings. Don’t save euros or dollars or any other fiat currency. Save gold instead. Every month or every quarter or whenever your budget allows, continue to accumulate and save physical gold. On some occasions its price may be higher, and other times – like 2008 – its price will be lower. But over time you will be happy with this savings program because you are protecting your wealth. You are saving sound money without counterparty risk. When the financial crisis is over and we get to the other side of the valley, your financial prudence will be rewarded.

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Does GoldMoney deliver physical gold to its customers? Marion, Madrid

JT: Yes, you can redeem your gold (and silver too) in the form of London good delivery bars without any cost. You can also receive kilobars and 100 gram bars, but you need to pay for the fabrication and handling cost of these bars. The transaction cost for these small bars is a few percent. We offer these co-branded small bars in conjunction with London-based Baird & Co., the UK’s major gold refiner. More info is available here: http://goldmoney.com/redeem-gold.html

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I would like to invest directly in gold, rather in mining companies, and I assume this means through an ETF. I am thinking of a 3-5 year investment. What is the downside apart from potential volatility of such an investment ? Dina Medland, Sevenoaks

JT: Buying gold is fundamentally different from investing in mining companies. The best way to explain this is by recognising that there are two different asset groups in a portfolio – investments and liquidity (i.e., what is often just called “cash”). Investments are wealth-creating assets, if they are successful. The focus is risk-vs-return. Liquidity in contrast is a wealth-preserving asset. Its focus is safety.

As I explain above, gold is not an investment. It is money. Money is a place to park your wealth while you are waiting to decide whether to invest it or spend it. Mining companies of course are an investment, and if successful, will generate for you a rate of return.

The downside risk of gold is that its price could decline. Even though as the table above shows, gold has generated double-digit rates of appreciation against nine major world currencies this decade, there is not guarantee it will continue to do so in the future. It is possible that central banks might reverse course and start pursuing sound money policies that preserve the purchasing power of national currencies. Therefore, one has to decide which money to hold, gold or national currency. The historical evidence and gold’s relative undervaluation make me choose gold, but everyone has to individually decide what choices for money suit them best.

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I have been bitten by the gold bug but in a very unpleasant sense. About six months ago I sold a number of Krugers to the dealer who originally sold them to me. His cheque for over 22,000 bounced and led to problems with my bank that are currently being considered by the Banking Ombudsman. I have tried to contact by email several UK bodies that appear to be Trade Associations, so to speak, for the Gold Bullion Trade but no one has responded -perhaps indicating that this really is an unregulated industry. I would like to find a reputable gold bullion dealer anywhere in England who is not going to attempt to bounce a cheque on me again. Can this be done ? Mr C M Chamberlain, Cheshire

JT: As I understand it, buying and selling gold coins is not regulated by the FSA. In fact, gold coins are not regulated in most countries around the world. So it is necessary to rely on knowledgeable sources, and one of these is the World Gold Council. It provides a list of dealers on its website at this link:

http://www.invest.gold.org/sites/en/where_to_invest/directory/

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I’m interested in investing in gold but want to understand it better. Is it always economic concerns that drive gold prices? Or are there other factors? Stuart Smith, Clapham

JT Like everything else, the price of gold is driven by supply and demand. The supply of gold is the approximately 160,000 tonnes in the aboveground stock. Demand is driven by whether people choose to hold gold or national currencies. Thus, it is mainly monetary factors that impact the demand for gold. If national currencies are being poorly managed, they are sold, meaning the demand for them goes down. Gold is viewed as an safe haven alternative to national currencies, so its demand goes up.

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To what extent do you believe the current gold price is reflecting investor sentiment or do you believe that fundamental demand is the primary driving force? SamHolland, London

JT: Gold is still relatively undervalued, so fundamental demand is the most important factor. Investor sentiment is growing, but still not the driving factor.

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I’m interested in buying silver. Is this a better bet than gold at the moment? Alison Bard, Newcastle

JT: I am more bullish long-term on silver than gold, but silver is much more volatile. Therefore it is not for everyone.

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