Fool's Gold

November 2010, Business2Business

Despite the current high price of gold, it is not a commodity that delivers good returns over time.

Gold has been increasing sharply in value over the past 18 months, however it is highly volatile and the sharp inclines are equalled in sharp declines. The current gold price is at its highest point since 1996.

Ideally an active investor wants to buy a stock when the price is low, giving rise to capital growth as the price climbs over time.

At the World Economic Forum in February, when the price of gold was at $US1150 an ounce, Billionaire financier George Soros was quoted as saying that gold was locked in the “ultimate bubble” and was “certainly not safe”.

To illustrate the high volatility of investing in commodities such as gold, the table below shows the level of risk and volatility (standard deviation) is very high compared to the low annualised return for gold.

_{*Annualised number is presented as an approximation by multiplying the monthly or quarterly number by the square root of the number of periods in a year.  Please note the number computed from annual data may differ materially from this estimate.}

As a comparison, using an Australian Equity portfolio (50% Australian and 50% NZ shares), the opposite is true – high return and much lower risk and volatility.

If, in 1996 you had invested $1 in a 100% Australasian Equity portfolio and $1 in the gold market you can see the difference in performance and return below.

_{Data presented may be based on a combination of actual returns. Past performance is not indicative of future performance. Graph represents a hypothetical investment of $1. Performance includes reinvestment of dividends and capital gains.}

The share portfolio has performed strongly over time, even when considering the Tech Wreck in the early 2000’s and the Global Financial Crisis of 2007/2008.

Commodities are often promoted as being a good diversifier in an investment portfolio as well as an inflation hedge. However, there is little evidence to support this claim.

The rules of investment don’t change in bad times. Markets still work, risk and return are still related and diversification across asset classes that offer a reliable reward is still the best strategy.