Golden assets

The concept of ‘black swan events’ was introduced by the Lebanese economist Nassim Taleb in 2004 to describe a situation where a surprise event has a major impact. The theory goes that we should be prepared for rare, high-impact, hard-to-predict events. The black swan was undocumented in the West until the 18th century and was presumed not to exist. So the theory goes that just because an event seems impossible based on past experience, it does not mean it will not occur. Taleb gives World War One and the September 11 terrorist attacks as examples of events that were impossible to predict, deemed highly improbable and yet came to pass. Taleb’s point is that we should expect the unexpected and have coping strategies in place. So what do investors do when a major calamity occurs? The usual kneejerk response is to sell stock market investments, buy government bonds and hoard cash.

GREECE EXITING THE EURO: A BLACK SWAN EVENT?

Until the recent Greek elections, EU leaders had appeared committed to doing whatever was necessary to preserve the currency union. However, events in Greece appear to be getting out of hand and plans are being formulated to cope with the hitherto unthinkable: a Greek exit from the euro. Were this to happen, the consequences for Europe and beyond would be hard to predict and potentially disastrous.

TIME TO BUY GOVERNMENT BONDS AND HOARD CASH?

Bonds issued by governments deemed to be safe, such as the US, Germany and the UK, are paying less than 2 percent per annum for the next 10 years. Cash on deposit is yielding similar amounts. Meanwhile, western governments seem quite happy to allow inflation to remain well above their stated maximum of 2 percent.

WHAT IS THE ALTERNATIVE?

Government policy aimed at keeping interest rates on cash and bonds below the rate of inflation for many years – to reduce the real burden of unaffordable government debts – is destroying faith in fiat currencies. In time, it will undermine confidence in the value of lending real money to governments today who will be returning funny money tomorrow. Could this be the time to buy gold?

WHY PEOPLE BUY GOLD

Gold is a hedge against uncertainty, rather like an insurance policy. The theory goes that if there is a calamity in financial assets, you will be glad you had some portion of your assets in gold. Plus:

• It is indestructible

• It has an inherent value

• It is a major requirement of the jewellery industry

• There is always a market for it

• It is inflation-proof over the long term

HOW TO BUY GOLD

Physical gold can be bought in bars, coins or jewellery. This appeals to a basic desire many investors have to be able to hold something real that they can see and touch. To avoid the security risk and the storage cost of holding physical gold, you could invest in gold funds or certificates. Another option would be to buy shares in companies that mine gold.

WHAT ARE THE RISKS?

Security issues aside, the main risk with buying gold is finding out with hindsight that the price you paid was too high. As a graduate I entered financial services in the 1980s when gold investing was very popular. Adjusted for inflation, the price of gold had risen (measured in troy ounces) from $200 in 1970 to $2,466 in 1980. However, by the year 2000 the real value was $400, an annual return of less than 2.5 percent over 30 years or an 83 percent loss over 20 years.

DÉJÀ VU?

Since 2000, the price of gold has risen from $400 to more than $1,500. So gold may have a place in your portfolio but it should not be seen as a get-rich-quick investment, nor should it represent a major part of your assets.

Philip Curran is an independent financial advisor based in Brussels