Can gold be mined for profits?

No matter how splendidly equity markets may perform, even the most unsentimental investor will always find something alluring in the precious gleam of yellow metal - gold.

As if to encourage the cupidity of investors in this, the sexiest of metals, gold markets have been bubbling away in recent weeks, while bullion prices have heated up.

Gold reached $360 (pounds 225) a troy ounce at the end of last week, up from $337 a fortnight before, as buyers stopped worrying European central banks would offload their vast gold stocks on to the market.

Small investors might now be tempted into the action by buying the yellow metal. But you could burn your fingers by dipping in - unless you really pick your moment.

"It's better [at this price] than above $400 ... but whenever small investors move in, it's too late and the smart money's already thinking of an exit route," warns Andy Smith, precious metals analyst at UBS, the Swiss banking group.

Nigel Tooley, director of the bullion department at auctioneers Spink, says: "It's a question of getting in when the price is low and getting out when it's high." You could have made a reasonable profit by buying gold a few weeks ago when it was pounds 208 an ounce and selling it now at pounds 223, he adds.

If you hope to join a gold rush, consider shares of gold mining companies Ashanti, Kinross or Driefontein. Their performance often exaggerates movements in gold prices. If you believe gold will rise, investing in gold shares would give you three times the result - either way.

Mercury Asset Management's Gold & General fund and Save & Prosper's Gold & Exploration funds are two high-risk unit trusts investing in gold shares.

People buy gold unit trust investments for several reasons. Save & Prosper's investment director, Michael Ashbridge, says: "Gold has a fascination with certain investors ... it always has a very speculative feel." But he adds that mining firms are increasingly able to get gold out of the ground more cheaply, while hitherto unknown gold deposits in Eastern Europe are becoming accessible.

Gold-based funds did badly in the past 12 months, with a pounds 1,000 investment having shrunk to pounds 705.21 in Mercury's fund and to pounds 861.61 in Save & Prosper's. But over five years the same investment has made healthy gains, standing at pounds 3,086.85 and pounds 2,321.47 respectively, according to MoneyFacts data.

Gold has traditionally been seen as a lasting store of value - an asset to hold when others are depreciating. But few of the old reasons for investing in it still apply. Economists believe high inflation will be a thing of the past for Western economies as European Monetary Union approaches. And with no exchange controls, the need to hedge against currency devaluation has diminished.

Fears persist that European governments will sell central bank gold to raise money to meet criteria for monetary union. The Dutch central bank compounded these worries when it said in January it had sold 300 tonnes of gold from its reserves. Andy Smith at UBS predicts that in a year's time the gold price will have dropped, though in the next month or two it could bounce up towards $400.

But prospects for gold are not all bad. Just before the 1987 stock market crash gold prices rose. This year, warnings from Alan Greenspan, the head of the US Federal Reserve, that stock markets are overheated could spark a similar spell of interest.

Demand for gold jewellery reached record levels at the end of last year, according to the World Gold Council, which monitors about 75 per cent of the gold market.

If you are looking for a good moment to buy, any December could be it. January is traditionally a good time for physical gold demand, with people buying jewellery for Chinese New Year, the Indian wedding season and Ramadan, says Rhona O'Connell, analyst at brokers T Hoare & Co.

So these days gold is best as a hedge or for cashing in on a short-term bounce in the market price. Long-term it is as useless as stashing money under your mattress.

Apart from short-term fluctuations, the price has stagnated over the past 10 years. Gold peaked at $850 an ounce in 1980, but since then it has cowered beneath $500. However, as our table shows, the dollar gold price index is distinct from local currency prices, which may be higher because of local demand.

If you decide to buy physical gold, the path is strewn with obstacles. If you buy gold bars, you have to pay VAT on them. And keeping gold in a deposit could cost you around 1 per cent of its value annually.

You can avoid paying VAT either by holding gold offshore, or buying krugerrands or sovereigns which are considered second hand and therefore not liable for VAT. Spink sells one-ounce Krugerrands at about pounds 10 over the market price (0171-930 7888).

Platinum can be a better short-term investment than gold. "When prices go up, platinum moves much faster and further than gold," says Jeremy Coombes, marketing manager at bullion company Johnson Matthey. The platinum market is much smaller, with world production only a tenth that of gold.

Johnson Matthey (0171-269 8000) offers investors bars of platinum in various sizes. For example, you could buy a 10 gramme bar for around pounds 100. Most customers leave their bars in store in Switzerland to avoid paying VAT.

Gold is good for a flutter or to diversify large portfolios. But look elsewhere for an investment that really gleams.