All that glitters is not gold

With the price of gold reaching an all-time high in early 2008, a new frenzy predictably emerged for the precious metal.

By Michael Low, CMA

Over the long term, gold has a track record of disappointing investors, so caution is warranted to those who are considering the addition of either gold stocks, or the bullion itself, to a portfolio.

Three reasons are typically cited in support of investing in gold, and each should be challenged and critically analyzed. The first reason is to protect against inflation. Yet in reality, the recent rise in gold occurred while inflation has been generally low. Expectations about future inflation have also remained low.

As a result, instead of gold, which doesn’t always move with inflation, an investor might want to consider owning inflation-protected real-return bonds. As their name suggests, these bonds pay interest rates that adjust with inflation, thereby minimizing the impact of any increase in inflation.

U.S. influences

The second reason people invest in gold is to benefit from a falling U.S. dollar. Because gold is priced in U.S. dollars, it historically has tended to move in the opposite direction of the U.S. dollar. That occurred last September, when the U.S. dollar dropped and gold rose. However, the price of gold has risen more than the dollar has declined, suggesting that its movements are affected by more than the U.S. dollar.

With that in mind, an investor may find that investing in a global portfolio of stocks and bonds is a more prudent option. That portfolio could hold its value even if the U.S. dollar declines further.

It’s also important to understand that stocks and bonds have historically provided better returns than gold. Consider what would have happened had someone bought gold and the stocks of the TSX at the beginning of any month since 1970 and held those investments for a period of 10 years. That person would have found that stocks outperformed gold eight per cent to five per cent. In addition, gold punished investors with a negative rate of return 38 per cent of the time, while stocks did not produce a negative rate of return.

The third reason for investing in gold relates to diversification, and the ability to offset declines in other investments. However, there is no proof that gold provides this advantage. In recent market declines, gold prices have dropped along with global stocks.

It’s true that gold could regain its position as an “unrelated asset,” but an investor may find that the best option is to stick with a wide variety of investments. While diversification does not guarantee a profit or protect against a loss in declining markets, disciplined, long-term investors may discover that diversification is a much better strategy for the long haul than counting on gold.

Michael Low, CMA, (michael.low@edwardjones.com) is a financial advisor with Edward Jones in Toronto.

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