Tuesday, 1 May 2012

Should gold cost £112 or 2p for grassroots investors?

A "grassroots" gold investor in the UK would have to pay a minimum of £112  to get on the bottom rung of the gold investment ladder.

Meanwhile a grassroots gold investor in India could pay less than 2p per day to make a gold investment.

Both of these investment schemes were pioneered by the World Gold Council (WGC) which told Gold ETF Investor that they both target the "grassroots" gold investors in their respective countries.

What's the problem?

By grassroots I mean normal people who may own gold because they own jewellery but who are, by default, gold investors. Meanwhile the WGC defines grassroots as the "demographic groups who comprise the Bottom of the Pyramid."

The photo above is of Kingsland Road in Hackney where even the £1 shops are undercut.

The fact that Hackney residents use 98p stores doesn't stop them from owning, selling and pawning lots of gold - enough gold to justify a huge influx of pawnbrokers and "Cash for Gold" shops like the Albemarle & Bond pawnbrokers in the picture.

The amount of gold these stores handle is not chickenfeed either. The scale was revealed by the London riots last year when an Albemarle & Bond store in Croydon was burnt down with £4 million of gold in its safe.

Surely the gold owners in these areas are grassroots gold investors or at the bottom of the pyramid?

The proliferation of these stores suggests there is at least a gold market at this level. But the cost of buying and selling the gold destroys the case for owning it as an investment. In the UK it is impossible to own gold on a small scale without its value being distorted by the high costs imposed when buying and selling.

However it is likely that the other key factor here is the lending rate people can get when they pawn their gold. Most pawnshops in Hackney will lend someone 60% of the value of the gold they deposit at a pawn shop. They then expect to be paid 8% an interest rate per month. That's not much risk for a very high return (150% per year) and no one seems to be undercutting these prices. In India gold loans can be as low as 12% per year.

Gold investing in the UK.

For gold investing to be worthwhile the fees for buying and selling it must not to wipe out the price movements.

An example was provided by ATS Bullion, next door to the Savoy Hotel on the Strand which sells physical gold direct to the public. It told Gold ETF Investor that the smallest pieces it sells are 1 gram bars for about £50 which equates to paying a 49% premium over the gold price.

At the higher end, if an investor wanted to buy a 1 kilogram bar (gold was about £33,000 per kg at the time of writing) they would pay a 4% premium.

For the 1gram bar example, the price of gold would have to rise 49% to more than £1,522 or $2,460 per ounce (oz) for an investor who bought a 1 gram bar to see any gain at all.

As such a 1gram gold bar is not a good investment.  

The popular alternative in the UK is to buy a gold ETF or exchange traded fund. Buying one share is equivalent to buying 0.1 oz of gold. At the time of writing the price of one share in a gold ETF was £100.60.

To buy one of these shares an investor would have to pay a stockbroker like Hargreaves Lansdown a fixed fee of £11.95 to buy or sell their shares. So, at this rate, buying one share would cost an investor 12% in fees. But buying 10 shares sees the fee fall to about 1% of the value of the trade.

That is already a lot lower than the cost of buying gold from a bullion dealer. As described above, the charge a 4% premium even when the size of the deal is £33,000.

The down side for the owner of an ETF is that they are unlikely to ever see the gold they own as they can only buy and sell their shares for cash. They also have to an annual management charge - some of which covers the storage of the gold in a vault - which is usually around 0.39%.

More relevant to the grassroots gold investor is that they have to have access to the internet, a bank account and a stockbroker and at least £112. They also need to be happy with the idea that they will never actually see the gold. That rules out most gold grassroots investors in the world and in the UK.

Another distinction between the UK and India on this front is the cost of pawning gold. In India the rates are much better - around 12% per year compared to 150% in the UK.

Gold ETF Investor asked the World Gold Council what it was doing for grass roots investors in India. It said:

"We have already developed a newer investment option for the grass-roots investor base in India – the gold-linked microfinance scheme. Initiated by the World Gold Council in 2008, the programme is an effective savings instrument for those demographic groups who comprise the Bottom of the Pyramid (BOP). They allow the purchase of gold in installments of as little as Rs 16 per day, following an initial down payment of 10-15%. By paying at the current price, buyers are offered protection against future price increases and allowed to liquidate their savings if they so choose. We believe this increased accessibility will act as a catalyst for further growth in Indian gold investment demand, alongside the more traditional investment options."

And the UK it said: "ETFs in effect allow 'grassroots' investors to access gold, as they seek to inform consumers about ways of investing in gold through adverts in newspapers and magazines. Moreover, platforms such as Bullion Vault (with whom the World Gold Council has a partnership in both the US and UK) also allow individuals direct access to gold."

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