Limit your investment in gold

Gold stocks and physical gold can present disadvantages. A study of the real (inflation-adjusted) return on gold from 1802 to 2012 shows that it rose only 0.7 per cent a year.


Limit your investment in gold. There are disadvantages to both bullion and stocks.

Gold trades at about US$1,800 an ounce. This is less than the yellow metal’s peak of over US$2,000 an ounce. That’s because the price of gold is benefiting from positive tailwinds. But when we publish our gold stock survey, we always outline its disadvantages. The fact is, gold has done poorly for over two centuries.

One disadvantage with gold stocks is that they can trade for more than they should. When the price of gold is high, gold stocks often trade at excessive price-to-cash-flow-per-share and price-to-earnings ratios. In most industries, investors would walk away when these ratios are excessive. Then again, price-to-earnings ratios matter less with cyclical gold stocks.

A second disadvantage with gold stocks is that they may face what’s known as ‘company specific’ issues. These can include floods, fires, strikes, a jump in costs, falling ore grades, expropriations, excessive debt and so on. Even if you’re right and the price of gold goes up, you could still lose money.

Even so, we advise you to continue to buy Toronto-based gold stocks Agnico-Eagle Mines (TSX—AEM; NYSE—AEM) and Barrick Gold (TSX—ABX).

No income; added expense

You can buy gold itself. This will avoid the problems of any given gold stock. But holding physical gold means that you’ll earn little, if any income. You’ll instead have to pay for its safekeeping. One way to avoid this is to buy gold ETFs (exchange-traded funds).

Another disadvantage with gold is that unforeseen events can roil its price. For instance, geopolitical instability can drive up the price of gold. The trouble is, how can you plan for unforeseeable events. It’s not like a successful retailer that can plan ahead about how many outlets to open.

More important, gold has an uninspiring long-term record as an investment. For 210 years, gold has delivered very poor total real (inflation-adjusted) returns. Jeremy Siegel, a professor of finance at the University of Pennsylvania’s Wharton School, studied the returns of different classes of investments from 1902 through 2012. One of these asset classes was gold.

Stocks for the long run

Let’s say that one of your ancestors had invested a dollar in gold in 1802. At the start of 2013 it would’ve inched up to $4.52. That’s a real (inflation-adjusted) return of just 0.7 per cent a year, Professor Siegel notes. Had your ancestor invested a dollar in a diversified portfolio of American stocks, it would’ve turned into $704,997 at the start of 2013. That worked out to a real return of 6.6 per cent a year.

Professor Siegel reaches this conclusion in his book Stocks for the Long Run. “In the long run, gold offers investors protection against inflation, but little else. Holding these assets will exert a considerable drag on the return of a long-term investor’s portfolio.” Indeed, after a run-up in the price of gold in 1979 and 1980, it subsequently generally drifted down in price until after 2000.

If you hold only gold in retirement, you’ll have to gradually turn your hoard into money, bit by bit. If you own a diversified portfolio of high-quality dividend aristocrats, you’ll earn a growing flow of dividends. You can pay your bills without selling your stocks.

This is an edited version of an article that was originally published for subscribers in the May 28, 2021, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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