Thursday, July 20, 2006

Gold - not a logical investment

Many advisers advocate having a portion of any portfolio invested in gold. I fail to understand why.

Over the longer term, gold has underperformed most of the mainstream classes of assets. Shares, property and bonds have all been better places to keep your money than the yellow metal.This is based on data going back to the 1930s. Sure, there have been occasions when gold has outperformed many other asset classes - but these have been rare (1979-1981 and 2003-2006) and the returns during this time have failed to compensate for the dreary return the rest of the time.

Gold is supposedly a hedge against inflation. Gold advocates point to the depreciating value of paper currencies as reason for buying gold. Often the arguments compare the price of gold against the value of a currency and adjust one or both numbers to reflect changes in purchasing power due to the effects of inflation. However, the analysis is often flawed as it does not make allowance for the return that would be earned on the paper currency in the period under review. Even a relatively modest return would show the paper currency doing better over the very long term (although taxes for some investors would affect the comparison).

Using selective time periods it is possible to produce numbers which show gold doing better than interest based investments - sometimes by a big margin. Using other selected time periods, you could show cash under the mattress outperforming gold. The point being that if gold is supposedly a store of value, it should be a reliable store of value. This is a test which gold fails. People who had the misfortune to invest near the peak of the last gold bull are still waiting to get their money back. They also would have missed out on the massive bull markets in stocks, bonds and real estate that served investors so well for most of the next two decades. People may wish to protect the real value of their investments, but over very long term periods, there are better options than gold. Over shorter periods, returns on gold are highly variable.

Gold's lacklustre performance over the last few weeks also calls into question gold's reputation as a safe haven in a crisis. At a time when world oil supply is barely keeping up with demand and a number of key supply sources are vulnerable to disruption, a shooting war in the Middle East should have given the price of gold a lift. It didn't - gold actually dropped. Instead investors flocked to the US$.

Most assets derive value from the fact that they can be used for something or produce a stream of income. So what gold is actually used for? The answer is not much. A huge portion of the gold produced annually is simply hoarded for investment purposes. Very little is used for industrial purposes. Add to this the fact that most of the gold ever produced is still in existence (a lot of it sitting in bank vaults) and I have to wonder why gold is priced as highly as it is? It seems to me that gold derives much of its value from the fact that people think it is valuable or because they find it pretty to look at. I certainly cannot see gold has having an intrinsic value which justifies its current price.

Maybe I am missing something here, but I really just do not understand why so many people advocate gold as a core investment.

1 comment:

Adventures In Money Making said...

taking your example, people who bought stocks at the height of the last boom, are still waiting to get back a quarter of their investment. With so many dot-com companies going bust, many probably never will.

People who invested in Real Estate during the last boom had to wait 10 yrs just to break even. They were probably pushed over the edge and lost a lot of money, some probably didn't recover to profit from the subsequent boom.

The idea isn't to get married to any particular asset class, but to understand the economy and invest in whatever makes sense at that point in the cycle.

Whether gold is good investment for you or not is a different question.
Most people who are investing in it have made a lot of money in other investments and feel the tide is turning. They're investing in it because they feel it will be a good hedge for the coming highly inflationary period.

Don't knock something based on someone article written by someone who wants you to buy stock!