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Gold: Is it a golden investment? or has the shine worn off?

Gold, some like wearing it, others worship it, and some buy it as an investment, but is it right to buy gold as an investment?

To answer this question, I guess it makes better sense to first define what an investment is, what gold is and see how it has performed based on an alternative.  Then we can make our own minds up, based on the facts.

What is an investment?

I checked out a few online dictionaries and they all gave slightly different definitions, but the main conclusions from each was the following;

An investment is an asset purchased with the idea that the asset will provide income in the future.

So, you could define a share as an investment, because the share may provide you with cashflows in the form of dividends.  You could define a rental property as an investment, because the property should provide you with cashflows in the form of rental income.

Therefore, as a generalisation, an investment provides an income.

What is gold?

Well, by the definition above, it’s not an investment?  Unless we bought some and let it out to others?  But a gold bar, is more of a liability than investment if you consider the storage and insurance costs?

A Gold ETF (Exchange Traded Fund) like the iShares – Physical Gold pays no income, so this could not be defined as an investment?

Because the iShares Physical Gold ETF is actually called an ETC (Exchange Traded Commodity) I looked up the definition of a commodity, and there you have it, gold is actually a commodity.  The definition being;

A raw material that can be bought and sold.

The price of which are dictated not by the discounted cashflows like an investment i.e. the current value of all future income, but by supply and demand.

I am not sure about you, but what would you prefer; a calculated current value, based on reasonable assumptions of future income, or an idea that this may or may not be in favour in the future.

Performance

So you can see, an investment provides future income streams and the current valuation of that investment is calculated based on these future income streams.  A commodity on the other hand is purely a raw material, providing no income of any form, and the current price is based on supply and demand.

Gold is valued in US$, so it’s fair to compare the historical performance of gold to a world stock market index, which reflects some of the larger traded companies around the world.

 

gold comparison to world stock market

The chart above shows a comparison of this.  The green line is the price of gold, and the red line is the world stock market, across the bottom of the chart is time, from January 1986 to the present date and the Y or vertical axis is the percentage change.

Gold returned 435% (c. 5%pa) over this 33+ year period, whereas the world stock market returned over 2000% (c.9%pa)

Conclusion

So there you have it, gold by definition is not an investment, although I am sure many will see their jewellery as an investment and may continue to buy gold as an investment in this form.

The performance is not inline with other available investments, and the above example is fairly reasonable since the downside risk and volatility of both gold and the world stock market are similar.

However, if you do want to include gold in your portfolio, limit your allocation to no more than 10%, preferably 5%, you may see gold in other portfolios.  Gold is often seen as a safety asset (although I could disagree, with drawdowns as much as -45%!) money often flows into gold when market nerves increase.

In the three years to the financial crisis in 2007, gold appreciated 63% compared to 45% in the world stock market, however in the three years to December 2000, gold only appreciated 8% compared to 60% in the world stock market.

In the last five months, since May 2019, we have seen gold rise 24%, but who knows what the supply and demand will be in the next year, it may be a completely different story?

 

 
NOW IT'S TIME FOR YOU TO HAVE YOUR SAY...

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