US dollars or NZ dollars — share returns still out-shine gold
Q: Why do you always get it wrong with gold? I would have thought by now you would realise your mistake.
Last Saturday you put a chart of gold in your column. Interestingly, it was in US dollars. We don’t live in the US!! It is hard to believe someone who is writing a financial column could make such a basic mistake as not doing the exchange-rate conversion!!
Over the past 12 months, as at writing, shares are down 18 to 20 per cent, gold is up 44.75 per cent. That’s a difference of some 64 per cent. Hard to believe someone can be so wrong. Please try harder to give accurate information.
A: Ouch!
Now that I’ve recovered, I’ve got a couple of questions for you:
● Why on earth do you read my column if I always get this wrong?
● Why is it that many of the angriest correspondents over the years have been big fans of gold? You should love it that I’m not urging readers to buy gold. It reduces your competition.
Never mind. In these trying times we all get a bit testy occasionally. And I take your point — perhaps the gold chart should have been in NZ dollars.
But, as I was trying to point out, during the period the correspondent was looking at there had been a big drop in the kiwi dollar versus the US dollar. So a lot of his gold gains were in fact currency gains. The chart removed that effect, and looked at just what happened to gold itself.
What’s more, everyone always quotes gold prices in US dollars. If you look at the Markets page in this section of the paper, you’ll see gold listed in American, not kiwi dollars. And on the radio they give the gold price in US dollars, often without even labelling it as such.
But okay, let’s look at the New Zealand dollar story — although not over 12 months. You can’t conclude anything over such a short period. How about the last 20 years? According to goldprice.org, over that period, up to last Wednesday:
● The price in US dollars has risen
524 per cent.
● The price in NZ dollars has risen
401 per cent. Hmmm.
This week’s graph gets around the currency issue by showing what would have happened to a $100 investment made in April 2000 in gold priced in both US and kiwi dollars, as well as in the NZX50 share index including dividends. All numbers are before fees and tax.
Not only do shares win, despite the recent plunge, but you can also see how volatile gold is, zooming up after the global financial crisis, but then plummeting.
If you think about it, over time we would expect average share prices to grow more than inflation. They represent ownership in companies coming up with increasingly better ways to produce goods and services.
I’m not so sure about gold. Sure, it’s useful — in jewellery, dentistry, electronics and computers, medals and statues. But there’s always the threat that someone will come up with great substitutes for any of these.
A win for the NZX50
Q: I’m the one who wrote to you last week about gold.
To even the field over price patterns, I’ve now done an investment from 2001 to 2020, and added dividends, tax and fees for the NZX50 share index.
The NZX50 ends at $817,000, and gold at $598,000. So a well deserved win for the NZX50. I agree that the best place for your 10-year investment funds is shares. Gold still has its place in the hard asset portion of your portfolio.
A: Thanks for being fair and looking at another longer period — and for reporting back on it. It’s interesting to see your findings are similar to those in the above Q&A, for a slightly different period.
Clearly you’re not one of the people sometimes called “gold bugs” who can’t see past the shine!
Smoothing volatility
Q: I agree with most of your comments regarding gold. The disadvantages of owning gold were very clear, but let me add the worst one: a wide buy/sell spread for physical gold.
However, the usual comments in your column revolve around the comparison of a single asset versus another, such as the perennial discussion on shares v property, or the recent one on gold v shares. Such debates are misleading because they mask the fact that investment performance is driven by asset allocation or portfolio construction, not by the individual components.
Portfolios with a modest (say, 15 per cent) allocation to gold show a much better risk-adjusted return than portfolios without gold. Gold is useful because it’s inversely correlated to most assets. A well constructed portfolio has assets with low correlation among each other.
Of course, a passive portfolio of 100 per cent index funds would perform better than any other portfolio in the “very long term”. But you have to endure enormous volatility in the meantime.
The holy grail of investing is to achieve a higher return with lower risk. A gold allocation can help you with it because of its inverse price fluctuation. It’s the overall portfolio performance that matters, not whether gold underperforms within a given timeframe.
A: You make some good points. I did say last week that holding some gold helps with diversification, but you go into this in much more depth.
But first, the buy/sell spread. That’s basically the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. A wide spread means the market isn’t “liquid”, so it might not be easy to sell gold at an acceptable price in a hurry.
Moving on to the importance of investing in a range of different assets, your comments echo mine in today’s first Q&A. Diversification across shares or across different types of assets can reduce risk without sacrificing return.
Academics at Trinity College, Dublin, in 2006 looked at the correlation between gold and share returns in the US, UK and Germany, to see if gold is:
● A good hedge, which means over time its price tends to rise when shares fall, and the reverse.
● A good safe haven in times of extreme market turbulence.
They found that gold is, indeed, a good hedge. However, it’s not so good as a safe haven, if an investor doesn’t already hold gold over the long term but jumps in after shares plunge.
“Investors who start purchasing gold the day after an extreme negative shock lose money after about 15 trading days,” say the researchers, Dirk Baur and Brian Lucey. That’s because share prices tend to bounce back up, and so gold tends to fall.
The conclusion: consider holding a small portion of gold over the long term, to calm down movements in your whole “portfolio” of investments. But don’t jump in and out of it.