Yuill Irvine: Gold may be slightly tarnished, but is sure to shine again

AGAINST a challenging economic backdrop, the vexing question for investors is whether their portfolios feature a holding of gold, given it represents an intrinsic store of value. Or does it?

Right now the topic is slipping down the agenda, but this situation is likely to be temporary. The reason is that any possible upside movement in the bullion price has been stemmed by some uncharacteristically bearish comment from a leading commentator.

As executive chairman of GFMS, Philip Klapwijk is considered by the investment community as the arch-guru of gold sector analysis.

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Ten days ago at the launch of GFMS's much-awaited annual 2010 Gold Survey, Klapwijk took the opportunity to reveal his anxieties regarding the current level of gold price, specifically the sharp upward investment demand, which has propelled the price from below $1,000 an ounce to $1,150 in less than a year.

He argued that demand is unsustainable and speculative and has devastated jewellery manufacturing, which is at a 21-year low, and has encouraged many people to sell their gold trinkets at prices way below the current price.

For example, investment demand in 2008-9 nearly doubled from 973-tonnes to 1,901-tonnes worth a staggering $60 billion. This is also the first time that investor offtake has exceeded manufacturing demand.

Klapwijk also suggested that a slack gold price for any duration might prompt less interest from both institutions and investors and, he said, there wouldn't need to be much selling pressure for the gold price to fall precipitously. However, he does concede that lower prices would generate increased demand from jewellery manufacturers and a decrease in scrap sales, although he believes that prices will have to decline to below $800 an ounce to trigger strong demand from the important Indian market.

GFMS's views are predicated on the assumption that more stable economic conditions lie ahead in the medium to long term. Nonetheless, they expect a strong bullion price towards the end of the year, perhaps taking prices to new record levels above $1,300 an ounce.

Interestingly, the increasing danger of a sovereign debt default by Greece, which could be followed by other Club Med countries, has only been accompanied by a modest uplift in the gold price so far.

For wealth managers and investors, the decision whether to buy should be easy, but patently it isn't. Gold delivers no income and is expensive to buy – and to sell later on. However, it seems that an increasing number of managers have been recommending up to a 10 per cent portfolio holding. Other professional soothsayers remain bullish principally as a result of some strong indications that the central banks, traditionally net sellers, have re-emerged this year as net purchasers. Last year, world central banks were sellers of only 41 tonnes of gold compared to 232 tonnes of gold sold in 2008. This of course pales into topical insignificance when compared to the 400 tonnes sold for $3.5bn by Gordon Brown ten years ago, which would be worth nearly $13bn in 2010.

China has now announced a planned increase in gold reserves, which the country proposes to increase to 1,000 tonnes of gold, while India has acquired 200 tonnes from the IMF, which will welcome the cash contribution for its impending Greek rescue-package.

Paradoxically, GFMS fails to mention the possibility of the world economy failing to achieve stability and sustained growth due to the debt crisis but it does concede that a collapse in investment demand "appears rather improbable".

On balance, there do seem to be good reasons to stay with gold.

Easily the biggest component of last year's record demand for gold were exchange traded funds which accounted for more than 600 tonnes – a huge increase.

In real terms, the gold price is still way off its 1980 peak equivalent to $1,600 an ounce.

GFMS calculates that the sustainable average cost of gold is now up to $950 an ounce, so the mines will be keen to see higher prices.

• Yuill Irvine is managing director of Dunedin Independent plc.