Why gold continues to sparkle

I wrote a blog the other week entitled ‘How QE can damage your pension’, a quick-fire summation of how the Bank of England’s policy of buying gilts with freshly-printed cash effectively depresses annuity returns.

But quantitative easing is having another, perhaps more visible, effect., one from which investors can actually benefit.

It has become clear that precious metal prices, particularly those for gold and silver, are being determined less by fluctuating supply and demand and more by the continued debasement of the US dollar, sterling and the euro brought about by a one-size-fits-all QE policy.

As soon as the US Federal Reserve announced a third round of QE last month, for instance, prices of both gold and silver enjoyed an immediate boost.

Investing in physical gold has traditionally been regarded as a prudent move once rampant inflation threatens to rear its ugly head. Accordingly, while official government figures on both sides of the Atlantic have indicated for several years that inflation hovers around 2-3%, there’s plenty of evidence to suggest that investors simply do not believe them. Relentless investor demand for the precious metal is one of a series of reasons why the value of gold has increased by 155% since 2007.

It is, therefore, reasonable to assume that a large proportion of investors have continued to buy gold as a hedge against inflation, a rather traditional, if not altogether proven ploy, designed to combat inflation’s corrosive effects.

Nevertheless, if it becomes apparent to a large enough body of investors that inflation has established particularly robust roots within a number of important western economies, demand for gold will almost certainly soar. Though predictions of gold hitting $2,500 an ounce by next summer appear fanciful, should official data suddenly reveal that inflation was exerting an even greater debilitating pressure on economic performance than previously imagined, we could see a protracted period of fresh investment in the yellow metal.

Yet a sloppily-applied QE strategy is not the only factor likely to influence short- to medium-term demand for gold.

The continuing eurozone crisis is also having an effect, for whereas emerging economies were once content to diversify away from holding reserves of US dollars and invest in the euro instead, their preference nowadays is to buy more gold. It’s a strategy with which it is difficult to argue.

Add to this mix the unwillingness of China to export any of its gold bullion since 2007 (important as it happens to be the world’s largest producer) and the continued propensity of reserve banks to build their gold reserves at a steady rate and the factors underpinning the continued rise in gold’s value become crystal clear. Little wonder that private investors are following suit – often with a tax-efficient twist.

Interest in old and historic coins has increased markedly over the past few  years. For example, the 29 different 50p pieces designed for the London Olympics are being hoarded by amateur collectors with up to 70% of them already out of circulation.

According to the Royal Mint, they are the most hoarded coins since decimalisation. Already, many of these specially-minted coins are trading well above face value on websites such as eBay where some buyers are willing to pay £1.30 plus postage (75p) for a 50p coin.

However, the Olympics, together with events such as the Diamond Jubilee and the continued rise in the price of gold is also fuelling investor interest in coins from the Victorian era and before, particularly gold sovereigns and half-sovereigns.

There is a wide range of methods by which investors can buy gold. From exchange traded funds to digital gold, Perth Mint certificates and gold bullion coins, much depends upon whether the buyer is acquiring the yellow metal as a speculator, investor, saver, or indeed a collector. Is your motive to register a capital gain or to use the metal as an inflationary hedge, or is it a little of both?

Diversifying a portfolio makes enormous sense and older gold coins should be not be overlooked, ostensibly because of their rarity value and scope for appreciation, although remember - the need to invest with the help of an expert is an absolute must.

Importantly from an investment perspective there are two crucial advantages to gold coins.

First, as a result of the EU Gold Directive, gold bullion and older gold coins are not subject to VAT. However, even more importantly, unlike other forms of gold investment outlined briefly above, British gold sovereigns are not subject to Capital Gains Tax (CGT).

It means that all post-1837 British gold sovereigns are CGT free because they remain legal tender and have a legal tender face value, an enormous potential benefit for investors when compared with other forms of gold investment. And of course, they’re completely unaffected by QE.

posted on 01 November 2012 15:20 byPJS