12 Jun Gold
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Periodically, and especially in (as Dave Grohl says) times like these, we get asked, “Should I invest in gold?”. Gold is one of those assets that is sometimes popular with investors and at other times not so much and some of this seems to be due to a sense of security that owning a ‘valuable’ physical asset brings. In a similar way to property, owning a physical asset that we can see, touch and think we understand is reassuring. We’re also drawn to gold or other precious metals because of the historic link to underpinning currencies and the belief that they provide some insurance against devaluations of currencies and protection in the event of extreme crisis. However, one could argue that in times of global crisis we are better off purchasing toilet roll, food or even guns. If things really turn out to be bad, tinned food may be more valuable than a shiny rock!
Just like any other asset, investors need to carefully consider why they are investing and assess the facts of what does and doesn’t work. It’s important to remember that the two key risks most of us need to plan for are funding a long period of retirement (longevity risk) and the erosion of the purchasing power of our income and assets over our lifetimes (inflation risk).
Assuming we’ve stocked up on food and toilet roll, let’s consider what protection and return gold provides. It’s seen as providing protection against currency problems and soaring inflation although it’s worth remembering that in itself, gold doesn’t provide or generate any return. What do I mean by this?
Most traditional assets that we invest in such as equities, property and bonds have two sources of returns. The first is the income that the asset produces, i.e. companies pay dividends, properties are rented out and bonds pay interest or coupons to the lender (the owner of the bond). The second return comes from the potential appreciation in capital value of the equity, property or bond based on several individual and economic factors leading to a price set by the market’s expectations for future cashflows based on all available information.
Gold does not generate a return. If you own gold you do not get a dividend payment or interest and nor do does it appreciate in value due to its application of capital and labour. The only source of appreciation for today’s purchaser of gold is the buyer of tomorrow who is more concerned or fearful and therefore is prepared to pay a higher price than today.
If we look at the price of gold over time compared to price inflation and an example of a diversified portfolio, we can get a sense of whether gold has actually provided a positive real return or not.
The chart above is based on the price of gold for 10-year periods to 1st May 2020, the UK retail prices index (RPI) and a portfolio invested 50% in growth assets (equities and property) and 50% defensive assets (cash and fixed income securities) over the same period. The gold price is measured in US dollars and isn’t converted back to sterling to remove any return, positive or negative, resulting from currency changes between sterling and the US dollar. RPI is used as a measure of price inflation for a UK investor with real returns calculated using the geometric method for discounting.
Over the last 10 years gold has only just provided a real return, over 40 years it has not and in both periods it has not provided a better return than a diversified portfolio. However, over the 20- and 30-year periods to 1st May 2020 gold has provided a positive real return; over the last 20 years this has actually been quite high at 6.5%pa, which is significantly higher than the portfolio.
So, what should we conclude from this? It could be argued that over the last 20 years being invested in gold has been a good investment decision but the problem with looking at historic returns is that they are rarely, if ever, repeated. The fundamental issue with gold is that, unlike investing in a diversified portfolio of businesses or other income-producing assets, it doesn’t generate any positive cashflow or income which can then be reinvested generating compound returns. An ounce of gold 20 years ago is still an ounce of gold today, less any associated costs (storage and insurance).
We rarely see headlines or people in rich lists stating that they made their fortunes buying gold and holding on to it. Some may own mining companies and most diversified portfolios will contain these, and although their return is linked to the gold price, they are still creating returns through the application of labour and capital.
In our view gold is a form of currency for which to exchange things, not an investment in itself so therefore shouldn’t be held in a long term diversified portfolio. If you’re worried about currencies devaluing or other economic problems then gold can be seen as a form of insurance in the same way that we purchase life assurance or disability protection. However, as you will depend on a functioning market to value and sell your gold you may wish to hold small denominations, like coins to trade, and suitable security measures to deter would be thieves!
It isn’t a suitable alternative investment for a long term investment portfolio that is based on capitalism, evidence and has the appropriate exposure to equities indicated by an investor’s risk profile.
If however, you have a thing for shiny rocks (or to be precise minerals) … be my guest!
Source: YCharts, DFA Returns 2 program and Bloomsbury Wealth. Gold price measured in US$ per Troy ounce with no costs allowed for, although there would typically be storage and/or insurance costs associated with holding physical bullion or coins. The diversified portfolio return is based on a simulated portfolio invested using a 50:50 split between growth and defensive assets rebalanced to its original asset allocation every quarter. Returns are after ongoing charges figures, custody costs and current Bloomsbury Wealth management fees at the then prevailing rate before any discounts. Income is assumed to be reinvested net of any withholding taxes.
This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person. Your capital is at risk when investing. Past performance is not a reliable indicator of future results.