Gold as an investment
By ATB Investment Management Inc. 6 September 2019 3 min read
The topic of gold as an investment is perennially in-and-out of the news as the commodity itself moves in-and-out of favour with investors. When economic times are weak, gold is promoted as a diversifying investment or store of value. When economic times are good and equity markets are on an upward trajectory, it is touted as a hedge against inflation. Gold is a lot of things to a lot of people, but is it a sound investment? Does it have a place in your portfolio? As with all investments, it is important to have a good understanding of the potential risks and rewards associated with investing in gold. There are several ways to invest in gold, each with their own unique set of risks.
How does one invest in Gold?
There are two main ways to invest in gold; physical delivery and an investment in the stock market. With physical delivery, you own the actual gold bars (or jewelry or coins or whatever other medium). One must have a safe place to store the gold, typically in a bank vault, which will incur storage costs. Then it is a waiting game as to whether or not your gold holdings increase in value. Investing in physical gold and paying storage costs make it harder for your investment to provide the same level of compound growth that one might enjoy with a stock market investment.
The second way to invest in gold is indirectly through an ETF, mutual fund or futures contract. An ETF can provide exposure to gold bullion and/or gold companies. Meanwhile, mutual funds are usually invested in gold companies, although some will maintain holdings in physical gold and/or futures. Both have historically been extremely volatile and are prone to extreme highs and lows. A futures exchange is a central financial exchange, similar to the TSX (the main Canadian stock exchange), where investors buy and sell standardized futures contracts. An investor who wished to speculate on the future price of gold would buy [or sell] a futures contract. Then it becomes a waiting game to see if the bullion price moves in the right direction and by the right amount, prior to the contract expiring.
"Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head." – Warren Buffett
What are the benefits/risks associated with Gold?
The most popular rationale for owning gold/gold stocks is as a hedge against inflation and as a means of further diversifying a portfolio. Truthfully, there are now other means to achieve both of those objectives, without investing in gold or gold companies.
The main risk with investing in gold relates to the inherent difficulty in valuing the commodity. Unlike companies, physical gold does not generate any cash flow and the storage costs mean there is a negative cost of carry. Plus, you will never receive dividends on bullion holdings.
This graph shows that gold did nothing from the 1980s to the early 2000s, dropping from a high of $660 USD to around $275 USD in 2000. An investor would have lost money holding physical gold for those 20 years. Recently it has done well, but how many investors were able to time it perfectly to sell gold in the early 1980s and stay out until the early 2000s?
What is our philosophy around gold?
Our investment philosophy is centered on sound portfolio construction. We do not maintain holdings in investments that we cannot value. CompassTM portfolios are globally diversified solutions that employ multiple sub-advisors that follow a disciplined bottom-up approach to evaluating investments [both existing and potential ones]. Bottom-up analysis focuses on finding companies that will perform well regardless of the macroeconomic environment. An analyst would begin with a company’s financial statements (balance sheet, income statement), and also consider various valuation measures. While our equity sub-advisors do not invest in gold, they may invest in a jeweler, for example. This type of company uses gold to create products they can sell for a profit.
Gold can be a viable investment, but as with all investments, it has to fit with your strategic plan and ultimately aid in the achievement of your long-term goals. You want to be able to continue holding your portfolio throughout the periods of market disruption and market gains. We know that building a diversified portfolio of solid investments and leaving them to compound over time is the best approach to achieving financial success.
This report has been prepared by ATB Investment Management Inc. (“ATBIM”) which manages the Compass Portfolios and ATBIS Pools. ATBIM and ATB Securities Inc. (“ATBSI”) are wholly owned subsidiaries of ATB Financial and operate under the trade name ATB Wealth. ATBSI is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Investor Protection Fund (CIPF).
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