I loved Spandau Ballet’s 1983 hit song, ‘Gold’, however Gold is a bit like the Marmite of the investing world; you either love it or you hate it.
For a minority of investors, often referred to as ‘gold bugs’, a bad word should never be spoken about this precious metal. Their obsessive belief in gold as the ultimate investment is unshakeable. However, for most investors, investing in gold is a pretty bad idea and here are three reasons why.
Firstly, and arguably most importantly, gold isn’t really an investment. It’s a commodity. An investment is something that has an expected return and generates wealth so because gold doesn’t produce any income, it can’t be considered an investment in the same way as company shares, fixed income securities (bonds) or property.
As a commodity with no ability to generate wealth, gold fluctuates in value as a result of speculation over its future value. It has limited supply, and opinions about the fluctuating future demand for gold is what prompts these changes in value.
Speculating is very different to investing. It’s certainly a lot riskier.
The second reason why gold is a bad investment is the difficulty you are likely to face trying to access this asset class in your portfolio. When it comes to investing in gold, you really face two choices; buying physical gold or using an investment product designed to replicate changes in its value.
If you opt for owning physical gold, such as bars or coins, then you need to consider the (high) cost of buying and selling, along with the cost of storage and insurance. It’s probably not a good idea to keep a load of gold bars in your safe at home, which means plumping for expensive storage facilities instead.
Investing via a digital product such as an Exchange Traded Commodity (ETC) comes with a different set of risks and considerations. If the ETC in question uses derivatives to track the performance of an index, you introduce counterparty risk to the equation, which could see you losing money if one of the lenders involved in that index tracking process fails.
If your primary motivation for buying gold is to have a store of wealth in case of a disaster scenario, then owning it electronically (or having it stored in a remote vault) is going to do you little good should the world around you collapse. In that scenario, the only gold with any real value is the gold in your pocket.
The third reason gold is a bad investment is because of a concept known as a crowded trade. Whilst there is no precise definition of the crowded trade, it generally describes a situation where a large number of investors share a similar sentiment and there is a heavy presence of short-term investors. These short-term investors are ‘speculators’ rather than ‘investors’. Those that invest in gold tend to be passionate about the investment, often lacking fundamental reasons for the allocation. A crowded trade is therefore likely to amplify volatility and risk.
These three reasons for gold as a bad investment should be enough to deter most investors.
Another important factor to consider is inadvertent overexposure to gold as a result of existing indirect allocation via mining shares in UK equity portfolios. Basic resources make up a little more than 8% of the FTSE 100 index of leading UK company shares, so it’s likely that within your investment portfolio you already enjoy some indirect exposure to gold.
There’s nothing inherently wrong with adding some gold to your investment portfolio. Assuming you understand how this commodity behaves, and you don’t get carried away with too much allocation to gold, then it can help to dampen down volatility during times of turbulent equity markets.
However please try not to become a gold bug, convinced as they are that gold is the be all and end all of investing options.
As Spandau Ballet sing in their hit song, True, ‘I know this much is true’!
For more information please don’t hesitate to contact Jonathan Gibson.