With equities struggling for momentum and the European sovereign debt crisis making previously safe government bonds look less assured, investors are moving their money into gold due to its status as a universal currency.
The price of gold has had a strong correlation with the escalation of the sovereign debt crisis. With Italian and Spanish government bond yields rising sharply this week amid fears of debt contagion, the gold price has pushed to its current all-time high.
The rise was compounded by fears that if Italy or Spain were to default on their loans then the size of their economies would mean a bailout would be impossible.
Performance of commodity over 3-yrs
Source: FE Analytics
"The euro is in meltdown," said FE Alpha Manager Tom Winnifrith, who heads up SF t1ps Smaller Companies Gold.
"But the dollar is also weak. The worst jobs data since the 1930s means that QE3 is now on the cards while the budget deadlock highlights just how poor the state of US government finances is. The days of the dollar being seen as the world’s safe reserve currency are drawing to a close."
Apart from holding physical gold in a vault, which is impractical for the average investor, there are three methods of trading the commodity: buying the equity of companies involved in the excavation of gold; investing in a fund that focuses on gold miners and other gold related-industries; or via an exchange-traded fund (ETF).
The latest FE Trustnet poll indicates that most investors prefer to access gold via a fund, such as Winnifrith’s. Only one in 10 investors holds gold in an ETF.
Source: FE Trustnet.com
According to data from ETF Securities, a company specialising in managing ETFs, gold makes up almost two-thirds of the entire commodity ETF universe.
Nicholas Brooks, head of research and investment strategy at ETF Securities, says that inflows to gold ETFs are aggressive when uncertainty pervades the market.
"At the start of 2011 growth indicators were good and the issue of sovereign debt had been put on the back burner, so managers shifted out of defensive sectors into cyclicals," he explained.
"In February and March the Middle East was hit by unrest and the debt crisis came to the fore so there were huge inflows into gold vehicles."
"Investors should notice that gold is closely linked to the perception of sovereign risk and the price will be pushed higher if the US follows through with the third round of quantitative easing."
Winnifrith believes investors should have at least 10 per cent of their portfolio exposed to gold and issued a stark warning to the 44 per cent of investors who do not.
"The writing is on the wall for paper currencies and the value is all too apparent in mid cap gold equities," he said. "It is foolish in the extreme to have no exposure to the sector but current valuations make right now both a prudent and an attractive entry point for all investors."
According to data from FE Analytics, SF t1ps Smaller Companies Gold has returned 71 per cent over the last year, more than double the average UK Smaller Companies equity fund. Winnifrith has predicted that gold will continue to rise and will even break the $2,000 an ounce mark in 2012.
However, Patrick Connolly, head of communications at adviser AWD Chase de Vere, says investors must be wary of the volatility.
"While it is very easy to be positive about an asset class that has already performed strongly, it would be a mistake to think that any investment will keep going up indefinitely, and when the price of gold does fall, it could be far and fast," he explained.
"It is possible that we are now in a gold bubble and those investing face the risk of losing far more on the downside than they could potentially gain on the upside."
Connolly says that many investors have access to gold without even realising it and warns that it may be too late to make the kind of returns we have seen up to this point.
"As most investors will already have indirect exposure to gold and other natural resources through broad-based equity funds, is it really sensible to take further risks by investing in – despite the general consensus – what has proven to be a volatile and unreliable asset class?"