Gold- a safehaven asset misused!

Over the past few days, we read many articles about the unfolding disaster in the gold investment scheme. The reports by the Star newspaper is unhelpful. The Star, which has no problem taking side in our domestic politics, adopted a 'balanced' approach when it comes to the gold investment scheme. If you read its articles, you may get the impression that the problem would not be a problem if Bank Negara hasn't intervened. The other part of the problem is the failure of Bank Negara to stay focused on the message. Avoid bringing up other issues that may confuse the public, such as tax evasion, money laundering, etc.

Let me tell you my first impression of this scheme, which happened two years ago. One of my customers came to me & sought my opinion on investing in a scheme with the following features:

1. You buy gold at market price and you can sell back at market price.
2. You earn interest at a rate of 2% per month. 

I immediately told her there is something not right about that scheme. I gave her an example. Assuming you invest in a dividend-paying stock, you enjoy the capital gain and dividend income. Example, if you have bought 1000 units of Nestle on Jan 1, 2011 (closing price RM43.30) and held it for 1 year, your gain is the capital gain of RM12.90 per share (since the stock moved up to RM56.20) and the dividend received of RM1.70 per share. In total, you would have made RM14,600.

Assuming you have invested in gold to the tone of RM43,300 on Jan 1,2011 which is equivalent to 10.2 oz of gold at a price of USD1376 per oz (cross rate of USD1=MYR3.10). As at Dec 31, 2011, gold traded at USD1635 or MYR5,150 (based on the cross rate of USD1=MYR3.15). Your investment would yield a return of RM9,017 (computed as follows: 10.2 oz multiplied by a gain of MYR884 an oz).

Now, ask yourself what is missing? Unlike investing in stock where you get a dividend income, if you invest in gold you do not get any income. That's why some pundits call gold is a barbarous relic because you cannot derive any income from holding gold. I do not subscribe to that opinion. To me, gold is a store of value. In the current economic environment where central banks are debasing our fiat currencies, gold is a defensive investment asset. Nevertheless, the sad truth is that it does not generate any income. Unless of course, if you consider lease rental of gold as an income. (Note: You can lease your gold to people who want to short gold). Even if you consider lease rental, the amount is next to negligible (less than 0.5% per annum). See the chart below. And, one more thing: To lease out your gold, you must hand over the possession of your gold to an investment firm. Sine you are keeping the gold, this source of income- however minuscule- is never in the equation.

From this simple analysis, you can ask the question- How can the gold investment scheme pay the handsome income of 2% per month? In addition, where would they get the money to pay handsome commission to the 'consultants'? If I were to assume that the consultants received a small commission of 5%, the management company incurred administrative expenses of 5% and let's factored in a small profit of 5%, the total expenses of these scheme would be 39%. Who pays for these expenses?

The same problem confronted the Roman Empire just before it collapsed. The solution was to debase their silver coinage, which means that you would get less silver than what was promised (here). The alternative is that you take from subsequent investors to reward the earlier investors & to cover the other operating expenses. So, many of the gold investment scheme are either cheating cases or Ponzi Schemes. That's the sad truth.

For those who like to invest in gold, my advice is buy physical gold from a commercial bank. Avoid exotic gold coins or get into a gold investment scheme. Stick to the well-established names like Canadian Gold Maple Leaf, Australian Kangaroo Gold Nugget, Swiss Kinebar & Singapore Lion Gold Coin. 


Chart: Gold Lease Rate for the past 1 year (Source: Kitco)