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Retirement portfolio planning shouldn’t miss out on gold

by Wayne Cheveldayoff, 2004-08-12

It’s unfortunately rare that an investment advisor or financial planner would advocate the holding of gold or other precious metals in a retirement portfolio.

This is partly due to the fact that gold is not considered to be a separate asset class like cash, equities, bonds or real estate.

Rather, if an investment in gold is considered at all, the discussion is usually focused on a comparison of the merits of owning the shares of a gold mining company versus other possible equity investments.

If the equity allocation is put in equity mutual funds, it is effectively left up to the fund manager to decide if gold mining equities should be included.

One seldom hears from advisors about gold being the world’s most-enduring form of money or its history as a store of value. Gold historically has been better in preserving wealth than cash.

This is where investors in North America may be missing the boat.

People in other areas of the world, such as India, have long ago learned the lessons of relying solely on investments denominated in paper currency and have embraced gold accumulation in some of their oldest customs, including religion and marriage dowries.

By holding gold in jewelry and other forms, they are essentially taking out some insurance against events that could diminish the value of their paper currencies.

At any point in time, it would probably be wise for Canadians to similarly take out such insurance by having approximately 5 per cent of their portfolios in gold or other precious metals.

A portion of this could be in the form of mining company shares but the main rightful place for gold in a portfolio is in the cash component because of its long-standing role as money.

It is not a question of giving up return for this insurance. Although precious metals have their ups and downs from year to year, their long-term performance is solid.

Gold, which is now trading at 10 times what it was worth 35 years ago, has definitely earned a place as a partial replacement of cash equivalents like treasury bills or money market funds.

In these highly uncertain times, one might even consider increasing the gold component of a retirement portfolio to 10 per cent, or even 15 per cent.

The higher risk stems from the potential further decline in the international value of the U.S. dollar in response to high annual U.S. government and current account deficits (US$435 billion and US$500 billion, respectively), and the unprecedented terrorist threat.

As the dollar declined and tension increased in the past three years, gold has climbed from US$260 per ounce to US$400 per ounce.

Many gold experts, such as John Ing, president of Canadian investment dealer Maison Placements, believe there is substantially more upside for gold, especially if inflation picks up again.

However, the positive outlook does not rest solely on currency and inflation fears, although the American red ink, partly due to fighting the war on terrorism, will remain an important factor, as will gold’s well-known role as a barometer of investor anxiety.

The other driving factor is a steady imbalance of supply and demand, with annual world demand of 4,000 tons easily outpacing the 2,500 tons being mined each year. Demand was also recently stimulated as some important gold mining companies turned from selling gold forward to unwinding such hedges.

While some central banks and governments, like Canada’s, have been sellers of gold in recent years, others have been steadily accumulating it and more of this appears likely in the future. Buying could come both from central banks and from citizens of high-growth areas of the world, such as India and China, where individuals have more wealth to preserve than ever before.

China, as Mr. Ing, a frequent visitor to China, pointed out in a recent published commentary, has a huge foreign exchange position, mainly in U.S. dollars, which are steadily eroding in international value.

“So far the Chinese have accumulated about 600 tons of gold or less than 2 per cent of their foreign exchange reserves in gold. Given the development of China’s national economy, we believe that China will moderately increase their gold reserves to 4-5 per cent of reserves…In time, China would like to have reserves in line with their European counterparts, who hold 13 percent of their reserves backed by gold.”

Some investors may recall the major gold surge of the 1970s, when the gold price went from US$40 per ounce in 1971 to a peak of US$800 per ounce in 1980. At the beginning of the run, the United States was entangled in the Vietnam War and was incurring huge deficits that were financed by printing money. Foreign investors became increasing reluctant to hold the U.S. dollar, causing it to fall dramatically. Later, the inflation rate accelerated and the annual inflation rate hit 10 per cent by the end of the decade.

Today’s circumstances are strikingly similar. The United States is at war with Islamic extremists, deficits have soared, and Federal Reserve monetary policy has been extremely accommodative. The U.S. dollar is being shunned by the international community and its value is deteriorating.

The one major difference from the 1970s so far is that inflation, while showing signs of stirring, is still relatively low.

Should investors bet that it stays low? It may be time for some portfolio insurance.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.

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©2004 Wayne Cheveldayoff