Investment consultant Tim Farrelly says he's suspicious of gold's meteoric rise.
"For something that is meant to go up at the same rate as inflation - it's been exceeding expectations substantially," he says.
The precious metal has moved from around US$250 an ounce in 2001 to a record of US$1424 as at 9 November 2010, and is poised for its 10th consecutive annual gain, data from the Chicago Mercantile Exchange shows.
Farrelly heads up the Sydney-based company Farrelly's and helps manage the asset allocation of the portfolio construction and investment management firm Implemented Portfolios by using exchange-traded funds (ETF).
He's purposely avoiding investing in the gold ETF or gold equities on the belief that the metal costs way more than it should.
"In the last 10 years or so gold is up 400 per cent while inflation, the US consumer price index, is up only around 25 per cent," he says.
"So either it is no longer a hedge against inflation, or it is substantially overpriced and I think it is the latter."
Farrelly believes gold should be worth only around US$600 an ounce, and he isn't alone in such bearish views.
Bubble building
"We are significantly underweight on gold," UBS Global Asset Management executive director and portfolio manager John Campbell says.
"We see it as quite a bubble building and the precious metal has been the classic risk aversion trade. People say that the US is going to hell in a hand basket and whether it's deflation or inflation, all your money has got to go into gold.
"But gold is at record highs and it gives zero yields, it costs you to store it and it's hard to imagine a more wasteful commodity in one sense that provides you with a negative yield but people buy the yellow metal because in times gone by it's worked, so everyone presumes that it will continue to work."
Campbell says the issue is that not only is gold overvalued, but gold equities themselves are very expensive.
Newcrest Mining, Australia's largest gold producer, is currently valued at nearly 25 times earnings, according to CommSec.
Similarly, mid-tier producers including St Barbara Mining and OceanaGold Corporation trade at price-earnings ratios of 25.5 times and 22.5 times, respectively. In contrast, the broader All Ordinaries Index trades at 14.61 times.
"Gold is a sector we are directly avoiding in the UBS Australian Small Companies Fund," Campbell says.
"We relate it to the technology bubble.
"You do analysis on virtually any listed gold stock in Australia, you then assume that gold prices will keep rising to records in perpetuity and the sector will have a merger and acquisitions boom - and you still can't get anywhere near the net present value of where things are trading at."
UBSGAM reckons US$800 an ounce is fair value for gold.
"The interesting thing about gold is that outside of its demand for jewellery and a tiny bit of industrial application, it has no use whatsoever," he says. "If you take away the investment and the hording and the so-called store of value reasons for holding gold and revert it back to just jewellery demand, we think it could fall a long way.
"We're not saying it will fall to US$800 straightaway, but that is a more realistic long-term price."
However, the gold bulls argue there are a raft of powerful drivers supporting the current gold price and that the metal's rally in fact has further to run.
A hedge against uncertainty
"All commodities have been rising and gold has also been a hedge in troubled times," dealer group Henderson Maxwell chief executive Sam Henderson says.
The firm is getting its clients' exposed to gold via the local gold ETF and also by investing in shares of Melbourne-based Newcrest and Oz Minerals.
"Around 4 per cent of the portfolio or more is in gold but that allocation changes depending on circumstances and on our investment committee asset allocation decisions," he says.
BlackRock Natural Resources' United Kingdom-based portfolio manager Catherine Raw agrees there is a lot of uncertainty lurking in the global economy, an environment in which gold tends to flourish.
"Throughout the 1990s you were in a period in which the US dollar was strengthening, equity markets delivered strong returns and generally we were in an environment where there was very little uncertainty; geopolitical uncertainty or financial uncertainty," Raw says during a Sydney visit.
"As we moved into this decade lots of things changed. We had the tech bubble bursting, we had September 11, and then we had the rise of terrorism, the rise of uncertainty and then most recently we had the financial crisis."
Stock markets from Asia to Europe and North America collapsed around or over 50 per cent in 2008, as the global economy plunged into recession after reeling from the shock caused by the United States sub-prime mortgage sector's bust.
While there has been a recovery since then thanks to trillions of dollars of government stimulus, it has been uneven.
Australia, Canada and the major emerging markets are recuperating relatively strongly, while questions remain over whether the US and Europe can break out from their horror downturn sustainably.
The woes of European nations Portugal, Ireland, Greece and Spain in particular have caused headaches, leaving market commentators concerned over whether their debt problems are deep enough to cause a global double-dip recession.
Currency worries
Yet Raw points out there is also a relatively new and strong trend supporting gold, and that is the strategic shift in attitude of major central banks.
She says that from the 1970s and onwards, central banks became net sellers of gold as the gold standard broke after the Bretton Woods agreement collapsed and the US dollar became the sole currency of choice.
"What's happened this decade is that you have begun to see that change," she says.
Central bank gold holdings in 2009 had a net increase for the first time since 1988, according to the World Gold Council and Deutsche Bank.
Combined reserves rose 425 tonnes to slightly over 30,000 tonnes in the 12 months, and have increased again this year. "It's not because emerging markets or somebody started buying, China first started buying gold back in 2002. Russia came out in 2005 and said they wanted 10 per cent of their reserves to be in gold," Raw says.
"What's happened is that the Europeans have stopped selling, so you have seen a net increase in official sector gold holdings as the Europeans have stopped selling but emerging markets have continued to buy."
Raw explains that central banks are snapping up more of the precious metal for the same reason individual investors are.
"The issue that you have as a central bank is that you want to protect your wealth. Up until recently a lot of your foreign reserves if you were China or Russia were in US dollars and suddenly the US dollar seems to be in a rush to be as weak as possible," she says.
"So if you are going to continue to hold US dollars then your wealth is going to fall in local currency terms.
"Then you think 'well I need to switch up from the US dollar so what currency do I switch in to?'"
Given that the euro zone's tensions are hurting the common currency, while the Japanese government in September manipulated the yen after it got too strong, there aren't many good choices out there.
"All of this tells you that any currency is challenged so you need to diversify across all currencies," Raw says.
"So our view isn't that central banks like gold, it's that they dislike everything else. That means you are seeing there has been a change of attitude towards gold as part of a core portfolio."
The BlackRock International Gold Fund has returned an annualised 12.55 per cent in the five years to 30 September.
Raw is currently favouring mid-tier growth companies with high quality assets and is underweight on large caps as they are more likely to struggle to maintain and grow production.
Some of the fund's top holdings include Newcrest, Toronto-based Kinross Gold Corporation, Peruvian mining company Buenaventura and Randgold Resources, which operates mines in Africa.
"We're trying to get the best leverage to the gold price. We're not focusing on the majors that are struggling to grow production because they got too big," she says.
"Barrick Gold is 8 million ounces of production. If you think that the average for the gold mine is about 500,000 ounces per annum, Barrick has to bring on 16 mines on per year in order to double production.
"Whereas if you were a company that only produces 1 million ounces then you only have to bring two mines on in a year to double production, so the ability to grow within the mid-tier space is much easier than it is if you are a major."
Falling production in South Africa
Baker Steel Capital Managers managing partner David Baker says the metal's price will hold up in the long run because South Africa, the globe's gold-producing mecca, has experienced a fall in production and no major deposits have been found recently.
South African gold out fell around 7 per cent in the year to June, according to South Africa's Chamber of Mines.
The country's mines are essentially reaching the end of their lives because they are getting older, deeper and grades are falling.
South Africa boasted an output of 1000 tonnes per year in the early 1970s, compared to 200 tonnes in fiscal 2010. "South Africa is still struggling and most places, if you look at Nevada, grades are falling and as grades fall you have to move more tonnage or you basically don't get as much gold out of the ground," Baker says.
"Producers are finding gold but probably not finding it as much as they need and particularly if you look at projected demand, so we think we're very much in an upturn with the gold price. It's not going to go up in a straight line but any weakness basically is a point of accumulation."
The Baker Steel Gold Fund returned 60.7 per cent in the 12 months to October, and has gained an annualised 17.8 per cent in the past five years.
Baker has made money for his investors thanks to bets on miners such as Resolute Mining, Great Basin Gold, OceanaGold, Newcrest and Nevsun Resources.
Inflation? Deflation? Gold's a winner
Since the global economic recovery, market commentators have debated whether the world would see deflation within several years because of benign growth in the developed world, or strong inflation or even hyperinflation due to moves by major central banks, particularly the US Federal Reserve, to print money.
Baker argues that whatever the scenario, gold will be a refuge. He says that there is every reason for clients to allocate 3-5 per cent of their portfolio to gold.
"If you go through deflation then people are going to be worried about the return of their capital because there is default risk and other things," he says.
"If you go through an inflation scenario, and that's the more likely thing, then basically inflation is the confiscation of wealth and it's more than likely that central banks around the world are going to have to inflate away their liabilities and the debt that they have got.
"There are a lot of unfunded liabilities in terms of medicare and pension liabilities, so it's more than likely that central banks are going to inflate or devalue that debt and those liabilities through inflation and in that instance gold should outperform."
AMP Capital Investors head of investment strategy and chief economist Shane Oliver agrees that more so-called quantitative easing should benefit gold.
"The increase in the supply of US dollars, yen, British pounds and euros will be good for gold as investors seek a safe haven from falls in major paper currencies," he says.
"This explains why gold has recently broken out to a new record high, even though inflation remains benign."
He says while the gold price has come a long way over the past decade, it is still well below its inflation adjusted peak of 1980, when gold rose above US$2000.
"It will likely head up to a similar level over the next few years," Oliver says.
Priced for perfection
Despite the sound arguments, Aviva Investors deputy head of equities Nick Pashias is concerned over whether all of the good news surrounding gold is baked into its price.
"We are just a bit cautious on gold at this point in time given the amount of positive sentiment which is there; we are also concerned about the high valuations of gold stocks in general," he says.
The Aviva Investors Natural Resources Fund has shed its exposure to gold over the past few months, moving from overweight to underweight.
"There is a lot of good news in the gold price as we sit here today," he says. "All I can say is that it seems to be priced for perfection.
"Our long-term gold price assumption is around US$900, so in our view it is currently overvalued substantially."
Pashias believes that gold will come under pressure if the US economy recovers and the greenback strengthens.
"The early signs of that recovery are starting to manifest. We have had a reasonably strong jobless number which beat market expectations," he says.
"The US isn't booming but it has bumped along the bottom and there are a few signs things are getting better."
Prone to sentiment change
Schroders head of Australian equities Martin Conlon says he doesn't believe there is ever a good time to buy gold.
"Its lack of cash flow or value in use means the prevailing gold price will always be a measure of sentiment rather than any objective measure of underlying value," he says.
"Most commodity prices have been influenced significantly by fundamental demand and partly by investment demand. Gold is almost solely the latter, making it far more susceptible to sentiment change.
"At a time when the world desperately needs capital to be put to productive use and the returns available on cash-flow-based investments are far superior, it would seem to only exacerbate gold's unattractiveness from my perspective."
He says the higher the gold price goes, the more the risk.
Tim Farrelly agrees.
"If you bought gold at the peak of the last bubble in the 1980s, 20 years later you would have lost 80 per cent of your purchasing power," he says.
"If you buy gold here as a long-term investment I think you will ultimately lose a lot of money simply because in inflation-adjusted terms it is near all-time peaks, which suggests to me that it's well and truly overvalued."
Clearly while the views on gold are split within the investment community, no-one can ignore the fact that it has delivered stellar returns in the past decade.
Whether its dream run can continue amid economic uncertainty and the reasons argued by Raw and Baker will be something that dealer groups need to assess during asset allocation reviews.
No doubt it will be a tough choice.
