Nervous investors are buying into gold and bonds – but these so-called safe havens aren't immune from risk, writes CAROLINE MADDEN
EXTREME VOLATILITY and uncertainty in the global economy has sparked a flight to safety. But with interest rates falling to historic lows, banking systems remaining fragile and talk of a government bond bubble forming, can traditional safe havens such as deposit accounts and gilts be relied upon to deliver risk-free returns? And for nervous investors hoping to protect their wealth by diversifying their portfolio, what are the alternatives?
Gold has long been regarded as a safe haven in turbulent times, and this economic downturn is no exception. According to Mark O’Byrne of Gold Investments (www.gold.ie), the price of gold rose by 5 per cent over 2008 in dollar terms, and 8 per cent in euro terms. Compare this to the Dow Jones which tumbled 34 per cent last year, or the Iseq index of Irish shares which plunged 66 per cent, and it’s easy to see the attraction.
The price of gold broke the $1,000 (€796) an ounce mark last March, and although it has dipped considerably since then, the price has now recovered as investors pile their money into the precious metal. On Tuesday it surged past $960 an ounce.
Gold has historically been a store of value in times of economic crisis. Although it doesn’t provide a yield such as interest or dividends, it’s a tangible, liquid asset and has the added advantage of being untainted by any of the issues that led to the credit crunch. And because it is negatively correlated with other asset classes such as equities, it can serve as a very useful form of financial insurance to hedge against financial shocks.
O’Byrne says that another reason why people are now interested in gold is to avoid “counterparty risk”, for example the risk that a bank will default. Gold Investments receive calls every day from individuals, both Irish and international, who want to put all their wealth into gold. However, even though O’Byrne is strongly bullish about the precious metal, even he wouldn’t advocate such a risky strategy. Investors shouldn’t allocate more than 20 per cent of their portfolio to gold, he advises, with 10 per cent being a sensible allocation.
“There’s an old Wall Street expression: you put 10 per cent of your wealth into gold and you hope it doesn’t work,” he says. “If the price of gold goes through the roof, it generally means your stock market, your property market doing as well.”
Gold is currently enjoying an eight-year bull run and O’Byrne is of the opinion that its price is still “far from peaking”. However, other commentators are more bearish about its prospects. Inflows into gold exchange-traded funds (ETFs), which trade on stock exchanges like shares do, have reached record highs in recent weeks, and some analysts see this gold rush as a warning sign that a painful correction may be on the way.
If an investor believes that gold’s bull run will continue unabated, how can he or she get a slice of the action? One of the most popular methods with Irish investors is to buy gold certificates from the Perth Mint of Australia. If an investor buys certificates, their gold is then stored in the Perth Mint, which has an “AAA” credit rating from Standard Poors. O’Byrne says that about 80 per cent of their clients opt for the certificate scheme rather than getting gold coins and bars delivered to them, “for obvious security reasons”.
The minimum order through Gold Investments is about €7,000, and the firm’s fees and the Perth Mint fees come to a total of 3.9 per cent on orders of this size. If a client invests more than €100,000, this once-off fee falls to 2 per cent.
Although there are no annual management or storage charges, O’Byrne says that the initial costs are too high for investors to take a short-term position on gold. Instead, they should be prepared to buy and hold for at least three to five years.
Another way of gaining exposure to gold is through ETFs, but unlike owning physical gold bars and coins, investing through the ETF route means that there may be a counterparty risk. Investors can also make a gold play by buying into mining stocks, either individually or through gold equity funds, but this is not without risks either.
Blackrock’s World Gold fund, which is available through RaboDirect, invests primarily in companies involved in gold mining. RaboDirect, which charges a 0.75 per cent fee on entering and exiting the fund, warns that “higher than average volatility is inherent in these types of investments”. Investors in such funds must bear in mind that they are speculating on the performance and growth of gold mining companies, rather than gold itself.
Fee-based financial adviser and founder of www.impartial.ie, Vincent Digby, feels that gold has a place in a diversified portfolio.
“It has performed strongly in the last while and if current conditions were to persist I’m sure it could continue to outperform other investments,” he notes. However, investors must take responsibility for their decisions and be aware of the possible risks. Digby warns that if the US economy “hits a bottom” and confidence starts returning to markets, “gold could lose a lot of its value”.
Government bonds, or gilts, have also been traditionally viewed as a safe haven in times of uncertainty, but there has been considerable speculation of late that a sovereign bond bubble is forming.
A bond is essentially an “IOU” issued by governments and large companies to raise money, and they pay an income to the lender, ie the investor, in the form of interest payments. Government bonds are generally considered safer than corporate bonds as they are backed by a State, and therefore the likelihood of repayment is generally higher.
Individual investors can buy and sell gilts through stockbroking firms, but many choose to gain a more diversified exposure through fixed-income funds, a wide range of which are available on the Irish market.
However, with government bond yields at historic lows around the world, what used to be a dull but reliable safe bet is increasingly being regarded as an overpriced bubble that will inevitably burst. US Treasury yields have fallen to such a low level that bond guru James Grant referred to them as offering “return-free risk”.
“Some of the fixed income funds may struggle because of the rate cycles [that have] already happened and if the reflation activities work, then yield curves could steepen up,” Digby notes.
If inflation were to pick up, bond yields would rise sharply, with the result that bond prices would fall (as a bond’s price moves inversely to its yield). “That would be a good sign for equities, but nonetheless it means it’s not the best time to be in fixed income.”
As capital security moves up the ranks in terms of investor priorities, life and pensions companies can always be relied upon to launch “capital guaranteed” investment products. Right on cue, a wave of these funds hit the Irish market last year when extreme volatility in global equity markets sent investors scattering in search of security. For example, New Ireland brought out a capital-guaranteed version of its Evergreen managed fund, while Friends First offered the Magnet Portfolio Secure fund.
With these types of products, the customer is guaranteed to get their original investment sum back at the end of a specified term, regardless of market fluctuations. Such a guarantee is undoubtedly very tempting to investors whose main priority is to protect their wealth from the ravages of the economic downturn.
However, as with anything that sounds too good to be true, there are some catches. There is generally a cap on returns, so for example an investor might be limited to receiving just 70 per cent of the upside in a fund’s performance. Some market experts argue that historically, capital-guaranteed products tend not to deliver any return at all.
A better alternative might be to invest in a low-risk managed fund, or a cash fund, although it’s vital to investigate a fund’s past performance and fee structure before taking the plunge. And of course there’s always the humble deposit account.
Until recently, the main risk associated with leaving money on deposit was the impact of inflation. If the rate of interest being paid on your account (after Dirt) was less than the rate of inflation, then the real value of your savings shrank. However, for the first time in almost half a century, Ireland’s inflation rate actually fell in January. On the other hand, the rate of Dirt increased by 3 per cent to 23 per cent at the start of 2009.
The main source of concern relating to deposits now stems from the ongoing turmoil in the banking sector. Digby has received many queries from clients worried about “apocalyptic” scenarios, but he believes that people should be reassured by the Government guarantee scheme in place to safeguard their savings.
“It is a very strong commitment,” he says. Under this scheme, all savings held by depositors in the seven Irish banks and building societies are guaranteed by the State until September 2010.
Other deposit-takers operating in Ireland are covered by various guarantee and compensation schemes. When choosing a home for their money, savers should make sure that they are fully informed on the level of cover provided by these schemes. A summary is available on the Financial Regulator’s consumer website (www.itsyourmoney.ie).
Falling interest rates are also making savings accounts less attractive. However, demand among banks for deposits has so far kept rates at a premium over the base ECB rate of 2 per cent. So savers should shop around for the best rate, while keeping in mind the varying levels of protection in place.
