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Gold bug? This one's for you

Posted by: Brian Dennehy
Membership level: Free
Many investors will allocate a permanent position in their portfolios for gold.  Is there evidence that this is a good approach for the long term?  We investigate.
 
We’ve said many times before (here, here and here, and most recently here) that it doesn’t make sense to have gold as a permanent part of your portfolio.  A look at the data backs this up.
 
We analysed annual returns for a number of different US assets going back to 1977.   The results are shown in Table 1 (original data courtesy of BullionVault).  A few points are worth highlighting:
  • US stocks had the best return, up 7,259%, almost 11x more than an investment in gold
  • Gold had the second most negative years, just behind commodities.
  • Equally, it had the second fewest positive years
  • …and the worst volatility (in terms of range of annual returns)
Clearly, holding gold for the long-term is not the best strategy, and its reputation as a safe-haven asset is daft.
 
Human drivers
 
Of course, more often than not it’s what investors believe that matters.  And exploiting investors’ beliefs (or behavioural biases) can be a very profitable strategy.
 
Example: in December 2015, simple sentiment analysis told us that an investment in gold mining shares might make sense:
 
“That investors tend to be most confident (bullish) about an investment just as it peaks, at precisely the wrong time, is well understood - though sadly most humans (wrongly) think this applies to other people and not them.  
 
The same applies in reverse - when most people are pessimistic (bearish) about an investment, you should not be selling - you should be buying.”
 
At that time, pessimism towards gold was extreme.
 
What happened next?  From December 2015 to Summer 2016 our recommendation, rose about 150%.
 
Now we are again seeing an extreme in pessimism. We explore the opportunity here.
 
ACTION FOR INVESTORS
  • Arguments in favour of holding gold for the long-term don’t stand up to scrutiny…
  • …but on occasions, there are opportunities to invest in gold…
  • A fund investing in gold mining shares will typically move more than the gold price (more risk but more reward)
FURTHER READING
 
 
Table 1: Total return and positive & negative years (1977-2016)
 
Asset
Total Return
Positive years
Negative years
US Stocks
7259.00%
34
6
Real estate
5615.66%
32
8
Non-US Stocks
2832.13%
30
10
Corp bonds
1876.15%
34
6
Bonds
1435.92%
32
8
Gold
647.60%
25
15
Cash
477.28%
40
0
US Housing
474.08%
34
6
Commodities
-0.02%
19
21
 
 
 
 
Inflation
281.82%
39
1
 
Data sourced from BullionVault.  Inflation: US CPI index, year end value; Cash: 3-month T-bill rate, daily average; Bonds: 10-year Treasuries, yield + capital value; US stocks: S&P500 index, capital + divs; Non-US stocks: MSCI EAFE, capital + divs; Corp Bonds: BofAML US Corp Master TR index; Real estate: FTSE NAREIT All REITs TR; Commodities: Reuters-CRB Continuous Commodity Index (CCI); US housing: S&P/Case-Shiller Home Price Series; Gold: Last London gold fix of the year USD
Topic: Sector analysis


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