The question has often been asked, "Is gold a good investment?" In this article I'll try to give you an answer or at the very least a framework you can use to answer the question yourself.
First we'll look at the history of gold and the reasons that it has played such a major role in human history. Then we'll focus on gold in the modern world, particularly its role in financial markets. Finally we'll take a look at the investment case and hopefully find an answer to the original question.
History of Gold
This may come as a surprise to you but gold was likely humans' first metal. Unlike other metals, which only occur naturally as ores that need to be refined, gold can be found in it's pure form.
Even today if you were to walk along the right river bed it is still possible, if very unlikely, that you can pick up a nugget. Additionally it is a very easy metal to work with, soft and malleable with a low melting point. This allowed early humans to make rather intricate objects with relatively primitive tools. Thus it should come as no surprise that many cultures around the world have placed a high value on it.
Gold's properties also make it a rather "good medium of exchange", or in layman's terms money. It is rare, durable, divisible, easily identifiable and fungible.
Rarity made it valuable, durability means that storage is easy, divisibility means that you can get change from a transaction, being easily identifiable means that others are more willing to take it as payment and finally being fungible means that it is uniform which will allow it to become the basis of rather large financial systems.
Over time, as global financial systems became ever larger and more complex, problems arose. In simple terms it is not ideal to determine monetary policy by how much metal is available.
A sudden influx of physical gold could easily result in inflation as when Musa I of Mali went on the Hajj pilgrimage in the 14th century. He gave away so much gold that values were depressed for years.
The gold looted by Spain in their conquest of South America had a similar effect. That said gold retained its central role in the global monetary system until the 1970s.
Gold in the Modern World
Due to its long history at the center of the world's financial system, gold retains a special status in our collective psyche. When times turn tough, many investors look to gold as a "safe haven", a place to park your wealth until the situation calms down.
Additionally many cultures, particularly in Asia, view gold very differently from other precious metals such as platinum. These dual demands for gold are often referred to as the fear and love trades.
The Fear Trade
Many investors buy gold primarily as a store of value in order to preserve their net worth when uncertainty increases. The fear of inflation is a particularly strong driver of this type of demand, but gold prices can spike on any form of uncertainty. The recent Brexit vote was an example of this.
As a gold investor, the Fear Trade is very important because it has historically been the cause of record high prices. If an analyst has an extremely high target price for gold, you can rely on the fact that he is looking for a spike in global fear and uncertainty.
The Love Trade
As I mentioned earlier, many cultures around the world have considered gold to be precious for millennia. The Love Trade refers to the demand for gold due to the fact that it is valuable and beautiful.
This affection for the yellow metal is particularly strong in Asia, where gold forms a part of many cultural traditions. India and China, due to both their size and recent economic revivals, are the strongest drivers of the Love Trade.
Unlike the Fear Trade, the Love Trade does not push prices to new highs, rather it acts a support when prices fall. You will see buyers enter the market after sharp falls, not just in the hope of a rebound, but also because it offers an opportunity to buy an asset they want to possess at a bargain price.
Supply of Gold
Almost all the gold ever mined is still around. Industrial usage is very limited, unlike platinum. If all mining activity were to cease today, we would run out of platinum in a couple of years but we would have enough gold stored away to last centuries.
Just a few years ago, an electricity shortage in South Africa caused platinum prices to go above $2000/ounce. At the same time gold prices barely budged.
In the James Bond movie “Goldfinger” the eponymous villain wanted to cause a supply shock by irradiating the gold stored at Fort Knox. I am afraid that fantasy is as close as we are likely to ever get to a gold supply shock.
Given what we have covered thus far, it should be obvious that If you are seeking to answer the question "Is gold a good investment?", it is necessary to look primarily at the fear trade.
So what are the potential sources of fear and uncertainty that can help drive this trade?
After the financial crisis of 2008, many central banks started “printing” money in order to stimulate their economies. According to some economic theories, this increase in money supply should have resulted in a drop in the value of money and thus inflation.
This has not occurred thus far. In fact many developed countries are actually facing deflation rather than inflation. It is possible that we will yet see hyperinflation due to loose monetary policy, but right now there is not much evidence of it.
War, Natural Disasters and Donald Trump
Inflation is the primary driver of the fear trade, but it is not the only one. Any factor that increases uncertainty has the potential to drive up gold prices. Even the potential election of Donald Trump may push up prices due to the markets nervousness about his policies.
Basically if you are a longer term gold investor, you by definition have a very pessimistic outlook on the global economy. You believe that purchasing and holding a non-productive metal will outperform real businesses that add actual value to the economy.
Many gold bulls point to a recent rise in gold prices as an argument for investing in it. This will only be the case if the global economy goes into a prolonged period of stagnation or even depression. I, personally, am of the belief that it is rather unlikely.
A Role for Gold in Your Portfolio
As a a single investment, gold really does not hold up versus the alternatives, but that is not to say you have to ignore it entirely. A prudent investor structures their investment portfolio like a chocolate cake, understanding that often the whole can be worth more than the sum of its parts.
Gold is what is often called a counter-cyclical asset. This means that when most asset classes move in one direction, gold tends to go the other way. By including some gold exposure into your portfolio, you can significantly reduce its risk profile without harming your returns.
If you look at the last decade or so, you will find that having gold exposure of approximately 5% of your total portfolio would give you the greatest benefit in terms of risk reduction, while still maintaining a reasonable return profile.
How to Invest in Gold
So if you decide to invest in gold, the next question to answer is ‘’How best to invest?”
You have a few options:
- Physical Gold
- Gold Coins
- Gold Miners
Is Buying Gold a Good Investment?
Is buying physical gold the best way to invest in it? I would argue that it is not. Physical gold has very few advantages over buying some sort of security that reflects the gold price.
It also has some very significant disadvantages. Most notably, the need for security. Remember, a physical asset can be stolen and stolen gold is impossible to trace since it can be melted and recast with relative ease.
If you have physical gold you can either hold it privately or at an institution. Holding gold at a financial institution will incur a cost. It also does not get around the distrust you may have in the financial system.
If you are willing to trust a bank with your gold, then you might as well buy an ETF or some mining stocks. The risk profile will be similar.
If you held it privately, the cost of security will likely be prohibitive and may make you a target for crime. Some might argue that buying physical gold is necessary since financial systems may fail and you cannot trust banks and other financial institutions to honor their commitments.
However, I would counter by suggesting that should things get that bad, you would be better off “investing" in guns and bullets rather than gold. Silver also trumps gold in this scenario. It's less valuable making it easier for you to conduct smaller transactions, and it actually has some rather interesting medical and industrial uses that will help support its value.
Gold Coin Investment
This is a special case of physical gold. It has all the disadvantages of physical gold, with a few extra added on. Some of the price you pay for a gold coin may be due to more than just its gold content.
Rarity and collectability may influence pricing. These are not factors that are going to benefit you in times of great uncertainty. Gold coin investment is better suited to coin collectors than gold investors.
Additionally do not trust companies that boast of large price increases in the value of their coins. The markets in which these transactions occur are very illiquid and susceptible to manipulation.
Exchange Traded funds are a reasonably cheap way to invest in gold. There is a cost involved in holding ETFS, but generally it should be less than you would pay to secure a similar amount of gold privately.
It is even possible to gear your investment using derivatives. I must warn you however that gearing will dramatically increase the risk of the investment
Gold Mining Stocks
Gold mining stocks are another way to invest in gold. They also come with inbuilt gearing relative to the physical gold price. This is particularly true for miners which have a higher cost of production.
A higher cost of production means that the price of the miner is much more sensitive to the price of gold. If your investment case was correct and gold does rise, then these stocks will likely see the biggest moves
Best Gold Stocks
Barrick Gold and Newmont mining are two of the larger and better known names in the sector. As such they are reasonably stable and should have a rather linear relationship to the underlying commodity. If you have a great deal of confidence in your outlook, you will likely get a better return from a smaller produce like Harmony Gold.
I would recommend Harmony gold in a rising gold environment due to it massive reserves in Papua New Guinea. At current prices the mine is marginal but if prices were to rise this would be the stock to buy.
If you are investing in gold, you are by definition pessimistic. You believe that the world will look worse in the future than now. If this were not the case you would find better returns in other asset classes particularly equities.
I am a bit of an optimist so I can’t really agree with this. I thus can’t recommend gold as your primary investment. That said, you should include some gold exposure in your portfolio to reduce risk and hedge its performance during times of uncertainty.
If you do decide to invest in gold, the best way is via an ETF or buying a gold stock. My preferred gold stock is Harmony Gold due to the fact that it has rather large reserves giving it a massive upside in the event of a spike in prices.
If you're just starting out, take baby steps and go slow as you learn the ropes. You can sign up for this free webinar that takes you through the steps of investing in gold and silver. The method really works and I personally have gotten 15% returns by following the method shared in the webinar. You can check it out here or click below.