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22 | Alternative investment
BusinessWeek just before the US stock market
began its two-decade bull market of the 1980s
and ‘90s. The Dot.Com Crash that followed
between 2000 and 2003 led a growing number
of people to seek out alternative wealth stores.
Whilst institutional funds overwhelmingly
chose fixed-income bonds, a growing number
of private investors began to buy gold, especially
as the central bank fix – led by the Bank of
Japan and US Federal Reserve – was to encour-
age a tide of cheap credit into all asset markets
via (then) record-low interest rates of just 1.0%.
This flood of money washed into house prices,
debt investments and emerging stock markets,
and it also pushed gold prices higher thanks to
two key events:
1. Leveraged speculation Holding a money substitute isn't such a bad side the collapse of Northern Rock,
Financed by the prime brokerage departments idea against this cataclysmic outcome.” Countrywide and Bear Stearns. Come July of
of the big investment banks, hedge funds the last year, a sharp drop in price from the all-time
world over piled into gold derivatives as interest A case of mistaken identity dollar-high then drove many existing physical
rates fell behind inflation in the middle of this Several big-name hedge fund managers have gold owners, especially coin buyers, to accumu-
decade. Between 2004 and 2008, they doubled also taken sizeable positions in gold so far this late more gold as the world economy slowed
the outstanding volume of US futures and year, including John Paulson of Paulson & Co. and financial markets went into a tailspin. The
options contracts, for instance, helping gold (who bet against sub-prime mortgages in 2007) leading metals refineries, however, weren’t
prices to double as well. and David Einhorn of Greenlight Capital (who expecting a rush until the usual autumn-time
2. Exchange-traded gold funds (gold ETFs) bet against Lehman Brothers’ stock while publi- spree, typically driven by India’s usual post-har-
As early as 1999, research for mine-industry cising its 40-to-1 leverage). But the broader uni- vest surge of gold buying at Diwali. (Rural India
marketing group the World Gold Council verse of hedge-fund investors, however, has has no formal banking system, so “investment”
(WGC) showed that very large investment port- been pulling in the other direction, reducing gold jewellery acts as a hard-money savings
folios could have made better returns with their exposure to gold amid the collapse of Bear account for many millions of people, making
reduced risk if they had included a four to seven Stearns, Merrill Lynch and then Lehman India the world’s No.1 consumer market.)
per cent allocation to gold, even during the gold Brothers. Gold futures and options were sold off Last summer's sudden jump in gold-coin
bear market of the previous two decades. Many alongside crude oil, emerging markets and non- demand also caught the world’s largest mints
retirement and mutual funds, however, were Dollar currencies as hedge funds were forced to napping as well, and so their clients, especially
blocked under the terms of their deeds from unwind their leveraged positions, first by their coin shops in Germany, the UK and United
owning physical property, especially in the investment-bank brokers raising the level of States, hit a genuine shortage of gold coins and
United States, and derivatives were seen as too margin calls and rolling costs, before withdraw- bars. The upshot today is that gold-coin sup-
risky. ing credit entirely, but also by their clients with- plies remain tight the world over, pushing the
How could these large institutions gain expo- drawing funds and demanding redemptions. average premium charged above professional
sure to gold prices? The WGC responded by Call it “mistaken identity”, says John “spot” market prices by US retail dealers up
sponsoring a series of funds that hold physical Hathaway of Tocqueville Asset Management. from five to ten per cent and more – even for
gold bullion in trust, securitising it for share- Because while the boom in gold derivatives the most heavily-minted coins such as the
holders and thus tracking the gold price. First required credit that was both cheap and freely South Africa Krugerrand. (The Rand Refinery
launched in Australia in 2003, and soon fol- available, physical gold in contrast only grew has issued well over 50 million gold Krugers
lowed by South Africa, the UK and then the more attractive as the banking crisis wore on. since launching in 1969. So there’s little rarity
United States, these exchange-traded gold funds No one’s obligation and no one’s liability, gold value compared to the plain “lump” of gold you
(gold ETFs) can be traded only during stock owned outright is quite literally the opposite of can buy in large bar form.) German-based
market hours. They charge 0.40% per year for debt, giving you the same tangible security as Heraeus says furnaces worldwide are still
storage (typically at HSBC’s bank vaults in owning real estate free of a mortgage, but booked solid to try and catch up. But with
London), reducing the gold backing each share instantly priced in a 24-hour international mar- stock-market investors still bruised after the
down to 98.3% and below of the nominal value. ket with deep liquidity. London’s gold bullion crash of 2008, demand from new buyers only
Already surging by 30% in 2009 to a total market, still the centre of professional gold- continues to grow, thanks not least to “the
valuation of $38 billion, gold ETFs are clearly dealing worldwide, turns over $60 billion per biggest interest-rate cuts in history...an unprece-
attracting significant new allocations from day, and this wholesale dealing in physical gold dented fiscal expansion,” as Gordon Brown put
mainstream pension and mutual funds. Yet the would be the least likely market to lose liquidity it at the recent G20 summit in London.
metal remains “institutionally under-owned” in a true financial crisis. That’s why, largely as a Injecting $5 trillion into the world economy
according to James Montier, London strategist result of the crisis in the credit markets, a small between them by 2010, the world’s leading
for Societe Generale. Pointing to conflicting sig- but growing number of high-net worth individ- economies are receiving “more money than ever
nals about whether the global economy now uals have already begun investing heavily in before,” said Brown. These historic doses of
faces inflation or deflation, Montier recom- physical metal. cash, plus the money creation of quantitative
mends gold as “insurance” against both out- easing, lead new and existing gold buyers to feel
comes. Because while “gold is the one currency Rush to physical gold that “price falls should be seen as buying oppor-
that can’t be debased” by inflationary policy, “a By March 2008, the very earliest gold buyers tunities,” say London professional dealers
significant prolonged deflation would see what’s had seen its price move from $250 above $1,000 Mitsui, “given the impact of global spending
left of our financial system likely to collapse. an ounce, making newspaper headlines along- programs on long-term inflation.”
April 2009 Investment International www.investmentinternational.com
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