Investors are turning to gold but should you believe the hype?

Gold has become an essential part of a sensible investment portfolio, being seen as a safe haven while stock markets fluctuate. It's also become a hedge against currency uncertainty and a standard recommendation for long-term planning, such as pension plans, because of its perceived secure nature.

With predictions that the yellow metal could soar again to as much as $2,500 (£1,650) an ounce (currently $910) it can look attractive. And fans point to the tremendous returns it has offered in recent years. Its price has climbed 140 per cent over the last five years, although it is only up 3.2 per cent over the past 12 months.

But investors should be wary of believing the hype, warns Adrian Lowcock, senior investment adviser at Bestinvest. He says: "Gold is a natural hedge against inflation and currency volatility. This means the price of gold will rise to compensate for a rise in inflation and currency prices. For these reasons it is seen as a safe haven. Recently gold has risen as the dollar has devalued against other currencies.

"However, the price of gold can move significantly and therefore short-term investors can still make a profit - or more importantly - a loss from investing in gold and should not treat it as the safe haven it is often described," he warns.

Readers with long memories will recall the gold rush of 1980 when prices soared so quickly that families were encouraged to cash in by selling their jewellery. But anyone who invested at the height of the fever is still waiting to see a turn on their investment, as David Kuo of The Motley Fool says: "Gold costs around $250 an ounce to produce but if we take the peak price of gold of $850 an ounce in 1980, and factor in inflation at 4 per cent, we can make a case for gold at more than $2,000 an ounce, too. With it currently around $910 an ounce, investors who bought in the 1980 gold frenzy are still out of pocket."

He points out the price of gold is driven more by sentiment than by actual demand. "This should be a red flag for investors," says Kuo. "If you are happy to hold an investment that does not produce an income but is driven by investment fashion then buy gold. But be wary."

You could make the same argument for almost any stock market investment, where sentiment or rumour unrelated to fact can drive share prices up or down. Unlike shares, however, gold has an intrinsic value which is why it has become regarded as a much safer haven. It's not immune from price slumps, but can prove a canny decision if you buy at the right time. With prices on an upward curve for half a decade, have investors missed the opportunity to buy?

"Gold prices can't rise indefinitely," points out Herve Lievore, investment strategist at AXA Investment Managers. "High prices boost supply and kill demand, as was perfectly illustrated by oil last year. Investor demand for gold is strong, fuelled recently by the fear of a systemic crisis and now by the growing concern on inflation. But high gold prices depress the traditional demand for jewellery, which account for almost two-thirds of gold demand worldwide."

Lievore believes that $1,000 per once is a key threshold that would be difficult to cross. "Gold prices proved to be remarkably resilient after the agreement reached during the G20 Summit in April allowing the IMF to sell more than 400 tons of gold, or 15 per cent of world consumption in 2008.

"In the year to date, gold has underperformed other commodities. That reinforces the attractiveness of the yellow metal in an environment with many uncertainties. But don't expect a 150 per cent increase like in the last five years," Lievore says. "There is a natural ceiling to gold prices above which the market imbalances. In my opinion, it is well below $2,000, possibly around $1,200-$1,300."

In other words, there could be some potential, but not as much as other commentators are predicting. The simple fact is that gold prices are extremely volatile. For that reason anyone investing in physical gold – normally bullion and coins, such as sovereigns, half sovereigns or Britannias – could be taking the highest risk. They will be most at danger of seeing their investment shrink if sentiment turns against gold in the future. On top of that there are normally storage costs for bullion or coins.

But you don't have to buy the metal to benefit from the potential gains gold offers. There are various other ways to invest. You could play the markets by spread betting on the price of gold, but, frankly, that's even more risky than buying the metal directly: a wrong decision when spread betting could see you lose much more than your shirt.

Alternatively, you could look to the stock market. Gold mine shares appear from time to time but often promise much more than they deliver. A less risky way to get into gold is to look at funds, either exchange traded funds or collective investments, such as unit trusts, investment trusts or Oeics.

With exchange-traded funds, investors hold shares of a fund invested in physical gold. Collective investments, on the other hand, will hold a number of shares in companies related to the gold industry, which could include miners, for instance.

"Gold is a sensible investment but it should not represent more than about 20 per cent of a diversified portfolio as it is too uncertain and volatile," says Ed Williamson, compliance manager at investment manager PIL Invests. "I would recommend some exposure through a collective investment vehicle such as a unit trust or fund. I think this is the better way to invest in gold over the medium or long term.

"There are various open-ended and closed-end funds on the market including BlackRock Gold and General Fund which has returned more than 160 per cent over the last five years. The Smith and Williamson Gold and Resources fund has also performed well."

How not to buy gold: The pyrites and wrongs

"Like any bull market, the tripling of gold prices since 2004 is now sprouting poor deals, rip-offs and scams," says Adrian Ash, head of research at online gold-dealers BullionVault. He offers the following advice to investors:

eBay.co.uk

The online auction house has seen a surge in gold-coin auctions. However, the prices paid can outstrip true gold-market values by 25 per cent. Review prices at eBay and the mark-ups charged on 24hgold.com and silverbids.com.

So-called 'rare' gold coins

Hard-sell dealers charge rip-off fees for what often turn out to be anything but rare gold coins. In 2004, a British company using this trick was shut down for selling coins at 700 per cent of their true market value. Spotting a rare coin takes experience.

New collectables

Collectable coins can cost a lot more than the actual value of their gold content. Even The Royal Mint marks up its coins by around 40 per cent, according to BullionVault. Modern commemorative coins rarely hold their price.

Over-pricing

Mail-shots, websites and radio ads are now selling gold to UK investors at 15-40 per cent above the true spot market value. Check the current spot gold price online.

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