What gold is NOT

By Larissa Fernand |  13-08-20 | 
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Larissa Fernand is Senior Editor at Morningstar.in. Follow her on Twitter @larissafernand

You cannot talk of gold and ignore critical components of human psychology.

Gold has been a symbol of wealth and power, a store of value, a means of exchange, legal tender, and has facilitated global trade. It is evident that it was considered the most powerful representation of wealth when nations adopted the gold standard which directly linked the amount of a nation’s currency in circulation with the amount of gold that is held in reserve.

Generations ago, when our ancestors did not buy stocks, when there were no Gold ETFs, where investment options were extremely limited, gold provided a great deal of security due to its recognition anywhere in the world.

It is fundamentally seen as a way to pass on and preserve wealth from one generation to the next. But it has also been a go-to investment during times of fear and uncertainty, which tend to go hand-in-hand with economic recessions and depressions, and conflicts, wars and geo-political turmoil. The security it gives to people, specially those who live in rural areas or volatile environments, is unmatched. As Warren Buffet once said, “Gold is a way of going long on fear”.

Gold is a universal currency. If you have to flee to another land, your currency may be trash, but not gold.

So when the debate on gold as an investment arises, it not as simple as it evidently appears to be. There are layered nuances that go into its timeless allure and mankind’s love affair with it over millennia.

The editor of Morningstar.co.uk, HOLLY BLACK, and MICHAEL COOP, Head of Multi Asset Portfolio Management (EMEA) at Morningstar Investment Management  share their views.

Gold is not a safe haven

With a reputation as a safe haven at times of uncertainty, gold tends to rise at times when other assets are falling.

As Mike Coop, portfolio specialist at Morningstar Investment Management, says, “People have a deep rooted, emotional response to gold. You can see that in how we refer to it in everyday language: good as gold, gold-plated, gold-class. We think of gold as safe, secure and as being the best and that impacts how people view it in investment terms too.”

A safe haven is an asset which holds its value – or increases in value – even in times of uncertainty. Does gold meet that definition? Probably not. Because, while gold sometimes (but not always) rallies during downturns, it tends to lose those gains during better times.

Brian Dennehy, managing director of FundExpert, points out: “Between 1980 and 1982, the price of gold fell 52%. Between 2011 and 2015, it fell 42%. This is not how a safe haven behaves.”

Gold is not driven by fundamentals

The stock market is, the old saying goes, in the short-term a voting machine and over the long-term, a weighing machine.

So, although share prices may fluctuate for various reasons – panic, euphoria, fashion – for a short period, in the end it is fundamentals that win out.

Over the long-term, the success of a business will be determined by fundamental factors such as profits, return on invested capital, and how it treats shareholders. The same cannot be said of gold.

Because gold doesn’t pay dividends or make a profit or loss, its price is only determined by investor sentiment. If it is in demand, the price goes up, if it is out of favour, the price falls.  “That means you’re simply relying on other people to be prepared to pay a higher price for an asset than you did,” says Coop.

While it may be possible to guess which way that trend will go in the short-term, this is speculating not investing. A glance at the performance of the U.S. stock market against gold since 1916 suggests that investing based on fundamentals tends to reap greater rewards.

Gold is not a currency

The main reason many people invest is to get an income. Dividend-paying equities and reliable bond yields produce pay outs that can be rolled back up into your investments, or drawn down to pay the bills. Whether it’s an ETF that tracks the gold price or bullion kept in a vault, gold patently does not pay an income.

Some would argue, instead, that the precious metal is a safe, physical store of value to be used when the going gets really rough. But there are problems with this argument, too. The idea of gold being traded and used in place of traditional currencies hinges on an almost apocalyptic scenario.

Coop says: “You can’t buy your fish and chips with a lump of gold, and a lot of pretty extreme things would need to play out for people to abandon their own currency and use gold instead. It’s a low probability game, and you’re a bit late if you decide to play it after the price has climbed so high.”

So what is gold’s position when it comes to your portfolio?

As my colleague Shwetabh Sameer says in this article, it is a good hedge to an investment portfolio as it does have the benefit of diversification.  It is also a hedge against currency depreciation.

Gold has a pretty reliable record as a go-to asset in times of market turmoil. However, it’s better viewed as an insurance policy than as a core holding. Investors who decide to add gold to their portfolios should be wary of the current hype surrounding precious metals. Right now the price has dipped amid vaccine hopes and rising U.S. yields. However, there are many not willing to write it off just yet.

Investment Involves Risk of Loss.

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Chandra Singh
Aug 14 2020 01:08 PM
 I commend the editor for this extremely timely alert to those who are tempted by the mob mentality. Similar rhetoric was frequently heard about gold touching USD 2000 per ounce way back in 2013 and all those who entered in that momentum, would have just recovered the capital if they would have remained patient. Two years ago, almost uniformly, everyone was enumerating the vices of gold as investment and any money invested at that time is what gave phenomenal returns. Even better with world gold funds which gave triple digit returns in less than two years. Unfortunately, this hype with the recent returns is too difficult to ignore for many new investors and they are bound to repeat the same mistake, as long as there is fear and greed!
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