Is buying gold (metal) speculation?

The rise in gold prices led many people, including some “financial advisors”, to think that putting money in investment vehicles that bet purely on price of gold is a good strategy. This is evidenced by the return of the popular gold savings account and the introduction of gold ETFs like GLD and IAU.

In my opinion, investors should exercise caution and take a serious look at the following figure derived from the book “Stocks for the long run” by Prof. Siegel.

2006-07-09-gold-returns.jpg

Larry Swedroe puts it this way:

1. Any commodity is bad investment IMO — (since there is) no expected real return .

2. Equities however must have an expected return to compensate for the risks, so if you are going to invest in gold IMO the way to do it is NOT to buy gold itself but to instead by gold mining stocks (which of course now involves equity risks, but at least there is compensated risk being taken).

My conclusion? Buying gold looks like speculation to me.

9 Comments

  1. choozm

    Recently I found that the amount of gold per share in GLD and UOB gold account declines over time to pay for the admin/mgmt fee. See http://tinyurl.com/ndl3t

    Well, what a weird investment… a depreciating investment? To profit from it, investors can only hope for upward price movement. And to hope for this is to bet that the condition *in the future* will be favourable, like inflation, weak dollars, wars, etc. Need a crystal ball? This looks like speculation to me.

    Great link to Larry’s post.

    Reply
  2. Anonymous

    There is a case for gold as part of asset class diversification.

    http://www.usfunds.com/media/diversify.asp

    Gold can generate real-returns. More importantly, it is to protect the purchasing power of one’s wealth against inflation / deflation.

    Reply
  3. indexfundfan

    choozm,

    True. It’s hard to bet correctly on the price of gold. I think people who are buying gold are just performance chasing and would likely end up disappointed.

    Reply
  4. indexfundfan

    Anonymous,

    Thanks for your comment.

    After looking at the the URL that you provided, I believe the Gold and Precious Metal asset class in the Callan table provided actually refers to Gold and Precious Metal equity (given by the Gold shares fund and World Precious Minerals fund) and not physical gold.

    This is exactly what Larry and myself have been saying: if you have to invest in gold, invest in shares of the gold companies. At least you will be compensated for the risk you are taking. However, if you buy the physical gold, your expected real return is zero (or negative after subtracting storage and insurance costs). This fact is borned out by the historical performance of gold (look at the figure again).

    There are some financial advisors who are confused and think that if physical gold could have a negative correlation to the rest of the portfolio, it is a good strategy to include into the portfolio. This is not true. The fact is that, a negative correlation is good only if the asset class has a positive expected return.

    For example, shorting the stock market (which has a negative expected return) has a almost perfect negative correlation to the stock market. But for most people, it does not make sense at all to be long and short on the stock market at the same time.

    IMO, the only reason why people are buying the metal gold is speculating purely on the price of gold.

    Reply
  5. Anonymous

    indexfundfan and choozm,

    There are a number of sound reasons why investors have chosen gold (and gold shares).

    Fundamentals:

    – Continued US dollar weakness due to massive twin deficits;

    – Gold production has peaked and new mines will not be up for next 5-10years (ie. tight supplies);

    – Growing affluence in China and India (main gold-buyers); and

    – As long as real interest rates are below the rate of inflation, gold price rises.

    These fundamentals can be challenged. Eg. physical gold buying in India have fallen very sharply, and gold price is being sustained by investor demand.

    Choozm: “I think people who are buying gold are just performance chasing and would likely end up disappointed.”

    Yes… a high number are hot-funds chasers. But others have been investing in gold way back in 2000-2001 at the early rise of the current gold bull. Eg. Starry.

    When buying gold, it an absolute necessity to have an exit-strategy. ie. know when to sell (eg. break of trendline support, hitting of fair-valuation target, and esp onset of public-mania, etc).

    The 1800-1997 chart by Prof. Siegel is not a fair comparison of gold as an asset class. The US was on the gold standard (1800-1972) so the value of gold was “fixed” and stayed very constant.

    A fairer comparison of equity vs gold real-returns would be from 1972-2005.

    This statement “the only reason why people are buying the metal gold is speculating purely on the price of gold” makes me go wow…

    So stocks/bonds are the “rational” investment choice and all else is “speculation”? Hmm… Oct 1929 Dow crash, 1989 Nikkei crash, the March 2000 Dot-Com bubble-burst…

    Reply
  6. indexfundfan

    Anonymous, you said

    When buying gold, it an absolute necessity to have an exit-strategy. ie. know when to sell (eg. break of trendline support, hitting of fair-valuation target, and esp onset of public-mania, etc).

    — therein is the main difference between your investing philosophy and the Vanguard Diehards (long-term buy-and-hold investors; sales are usually only triggered by re-balancing needs).

    The argument on this can go on forever and there is no end. Enough said.

    Reply
  7. choozm

    S&P500 annual return 1972-2005 (capital gain only, i.e. it is handicapped because dividends not reinvested)
    http://www.pankin.com/dow/annual.htm

    Gold historical price 1975-2005
    http://www.kitco.com/charts/historicalgold.html

    Start at 1975-1-2 using gold price US$175, and grow S&P500 using same US$175, then get XIRR for the end of years below:

    Gold XIRR (before inflation) since 1975
    1987 (crash) = 8.14%
    2002 (bear) = 2.48%
    2005 = 3.53%

    S&P500 XIRR (before inflation) since 1975
    1987 (crash) = 12.85%
    2002 (bear) = 9.54%
    2005 = 9.81%

    That’s all from a long-term buy-and-hold investor’s point of view. Bye.

    Reply
  8. goldguru

    If you would have used gold as your currency over the past 5 years, rather than dollars, consumer prices would have declined by 50%! Check it out:

    Consumer Prices Down 50% Over Past 5 Years! (Priced in Gold)

    Reply
  9. indexfundfan

    goldguru, thanks for commenting.

    Well, if it is money meant for investing for the long term, there is no reason to keep the paper notes under the mattress.

    Consider the story: Suppose the ancestors of two persons, way back in 1800 each received $1000 as gifts from a rich person. The ancestor of person A, decided to invest the money in a diversified mixture stocks while the ancestor of person B thought that gold was ‘safer’ and went to a gold shop, bought the $1000 equivalent of gold and kept it safely under the mattress.

    Let’s fast forward 200+ years to the present day. Now the question is this: Would you rather be person A or B? See the chart above and decide for yourself.

    Reply

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