Why gold is not considered for long term investment?

POSTED BY Paul ON February 15, 2013 3:39 pm COMMENTS (12)

 

Hi All,

In many blogs/articles, I saw that investing in gold for long time is not beneficial. We should not have more than 5% allocation for gold in the portfolio. etc…

Why is it considered as a bad investment? Is it because, the returns from equity always surpasses the returns from gold in long investment horizon?

I read gold has a negative correlation with equity. When the stock market is not doing great, the investors invest more in gold and the gold price rises. Similary, when the stock market is doing good, the gold price tends to be low. Is this information true?

Our market is going to be volatile. There will be ups and down. One way to handle this ups/downs is by investing using SIP. By investing through SIP, cost of units will be averaged, and is beneficial in longer run. When stock market is not doing so great(lower NAV), we get more units. Some people even buy more units by pushing extra money, to lessen the average cost of a unit. When stock market is in a bull run, we buy lesser units. But still it is increasing the average cost of the unit.

So instead of buying stock, when the stock market is doing good, why cant we invest in gold? Gold has the negative corelation thing with equity. So the gold price has to lower when stock market is doing good. Since we are not buying more equity units through SIP when the price is high, the average cost of the units will be lesser. Later when there is downside in the market, we could again invest in equity. If required, we could cash the gold that we have acquired for a lower price (gold should have a better price now, since the stock market is down). And buy more equity units. Thus we could have lower cost per equity unit.

I understand the above will work only if the equity market plays a major part in the valuation of the gold. If there are many more factors that affect the gold price, then it is not guaranteed to have the negative correlation to equity.

Am I thinking too much/stupid. I know it does not sound good to say invest in gold when stock market is doing good and invest in stock when market is not doing good. 

Is there any other commodity like gold that have negative corelation to equity?

Please suggest.

Thanks,

Paul

 

12 replies on this article “Why gold is not considered for long term investment?”

  1. Dear Paul, don’t yhou feel you are putting to much pressure on yourself for the thing – I’m late & left behind so I w’d run hard.

    Relax, my dear friend. You are giving too much importance to market volatility. Ust sample a simple scenario – As per your mly date of rebalancing, the market remains same & just a day after a 300 or 400 point correction either upwards or downwards (in terms of sensex) is there. What ‘ll you do?

    KISS ‘ll do far better things to you rather than all these complex exl. calculation. Also human psycology &* the general attitude, ‘ll soner or later catch you up & you may not find your emotionless investing too much appealing & may dump the same for some othre flavor of the season.

    Please try to understand the bottom point of dear Ramesh’s reply, too much tinkering with your portfolio ‘ll not yield high. Add the taxation issues & charges etc. & you ‘ll come to know what he mean.

    There is one more thing – you can not rebalance in Gold as per your calculation. the reason is if you are investing in Gold ETF, the unit price of gold ‘ll define your purchase quantity & investment not the reverse.

    thanks

    Ashal

  2. Paul says:

    Ramesh,

    Thanks for sharing the link. I will go through it.

    Thanks,
    Paul

  3. Paul says:

    To add one more point.

    I am thinking of doing this to make the volatile market to my advantage. So doing reallocation every year will not give me the benefits of volatile market. So I think I have to do this every month.

    Thanks,
    Paul

  4. Paul says:

    Hi Ashal,

    It is not about timing the market. I will do investment every month like anyone else. but the proportion of money I invest in equity and gold will vary according to the present conditions.

    For ex, this is a simple investment scenario. Here I dont chose SIP. every month, I will buy the mutual fund/gold fund units directly.

    Suppose I can invest 10,000 per month. I already have enough debt exposure by EPF and PPF contribution. So this 10,000 I will invest only in equity and gold only.

    By normal allocation, for first month, I invested 9,500(95%) in equity and 500(5%) in gold.

    Next month, I check the gold price. If there is no change/minor change, I again invest 9500 in equity and 500 in gold.

    Next month I check again. I see that gold price is reduced by rs. 300. (Around 10% reduction). I need to invest more in gold now. I am thinking of investing 10% of amount invested in equity (rs. 950) to be moved to gold. I have not yet thought from which mutual fund I will take this 950. Maybe I will invest some amount less in all mutual funds. So that I can make this 950. Or I take more from MF that is not performing well and less from an MF that is performing well. This month, I invest 8550 in equity and 1450 in gold this month.

    Next month I again check the gold price. If the gold price is again reduced by 5%, I move 5% amount that invested in equity to gold. Around 430 more to be moved to gold. This month I invest 8120 in equity and 1880 in gold. Or I will round it to 8100 in equity and 1900 in gold.

    Next month I check the gold price again and find that gold price increased by 5%. So I will move 5% from gold to equity. 405(400) to be invested more in equity. So this month 8500 in equity and 1500 in gold.

    Like this I will check the gold price every month before investing. And will do re allocation in my portfolio. If re allocating every month is a bit of overkill, we could do this for every year. Investing for a long time frame of 25/30 years will have some benefits.

    If the negative corelation of gold to equity holds, when the stock market is going low we will be buying more equity units at a low price. When gold price is low, we will be buying more gold units. Thus reducing the average cost of gold or equity. Lower averge cost will result in higher returns?

    But if the inverse relation is not kept, then no use in doing this every time, I make investments.

    Thanks,
    Paul

    1. Ramesh says:

      You should read David Swensen (a portfolio manager of Harvard endowment). Search for Lazy Portfolios.

      He proposes to do exactly what you are saying. He uses more asset classes, namely, equities (divided into domestic which is US for him, and international), bonds, cash, TIPS, and alternatives like commodities. He does daily rebalances (much more frequent than your proposed monthly). But he can do that, because his is a tax-exempted trust account.

      For you:
      1. You are not free from tax-issues. So the more you want to balance, more will be the transaction and tax charges, which will eat into your overall return.
      2. You do not have either the various options available to him or even available to US investors. Namely, REITs, simple commodities funds, the low cost index funds pertaining to numerous asset classes, both US and abroad. While, you do not have so many options.
      3. Your idea is still correct. I prefer to do the simple monthly investment into the asset which is trailing. For example, I start with 50:50 of equity:debt (similar to your equity:gold) for illustration of the principle. In month 1, I have put 50000 in equity and 50000 in debt. Suppose I have a stream of 5k per month.
      In month 1, if equity goes to 55000, while debt goes to 51000, then I will put 4.5k in debt and 0.5k in equities.
      In next month, equity goes back to 50000, while debt goes to 56.5k, then I will put 5k in equity making it 55:56.5. You see still a gap with my original target value. Ideally, it should go to 55.75:55.75 but because of transaction costs and tax (whether short-term or long-term), I will just wait for next month.
      I will keep doing the same thing month on month, and try to balance the two by putting MORE money in the lesser asset. It has been shown, that whether you do balancing at monthly intervals, or at yearly intervals or even 5-yearly intervals, the overall effect over return is always positive rather than letting the asset allocation go out of whack. If you are able to do rebalancing in a non-emotional way, things will get settled.
      Also, understand, you can theoretically do rebalancing every second too, but will that really benefit you.

      Swensen used to do it daily, since he could do it, he is a genius (other term for mad), he had got a lot of money to manage and he did not have to pay taxes. 😉

      1. Paul says:

        Hi Ramesh,

        I am talking about only investment reallocation every month. I am not reallocating my entire asset. I am not going to sell gold units to buy equity units. But I am going to adjust my monthly investing according to the present conditions of the market.

        Whatever is invested remains invested. It is the additional investments, that is re allocated every month. Investing more in gold when gold price is less. Investing in equity when the stock market is running low. The only principle behind this approach is to keep the cost per unit as low as possible. That can be achieved only if we buy the equity/gold when equity/gold market is performing less.

        I chose to track, gold price, because it is easier to track than NAVs of multiple MFs.

        Even if I am not able to sell gold and buy equity units, because of the tax issues, I can do that later, after the locking period of 3 years. After 3 years, if I find the equity market is low, I can redeem few gold units to buy equity. But here there is a market timing in play. I need to decide whether this is the right time to move my gold investments to equity. But in that case also, I have always bought more gold units when the gold unit price was low thus having a lower average cost per gold unit. So at any time that I am selling, if I can get my targetted return over average cost of gold unit, I can convert gold into equity.

        Otherwise, it is just allocation of investment that I am doing each month. It is not complete portfolio re-balancing.

        Thanks,
        Paul

        1. Ramesh says:

          Two points.
          1. Monthly contribution changes in those small amounts will not yield much benefit. Dont believe me. Just do some of that using 3 years’ or 5 years’ data. You can easily get monthly NAV values of gold and any simple equity fund. Then run your idea through it. Overall, monthly contributions will be a very small part of your total portfolio, and thus, any perceived benefits will be very small. An easier method will be to do yearly SIPs of a determined value, and change the values of SIPs every year after looking at your overall portfolio. <-- Much easier to manage. 2. You have mentioned doing more in gold when gold is lower, but at the same time, you say, you will remove money from fund which has performed less. Actually, you should invest more in the fund which has performed less (same play- more units at same cost). Read more, learn more.

          1. Paul says:

            Hi Ramesh,

            What you said is true. I should invest more in funds performing less, to get more units at a bettr cost.

            I am thinking of this approach, may be because I am ultra conservative. I dont want to be in trouble, if stock market goes down again and gold rules once more.

            So the basic ideas are the following.

            1. I will be investing some specified amount every month, whether the market is good or bad.
            2. If you can make the average cost per unit(equity/gold) as low as possible, the returns will be higher.
            3. The price of equity units and gold units are negatively correlated.
            4. Buy equity, when the gold price rises.
            5. Buy gold when gold price gets lower.
            6. Convert the gold units to equity units, when the returns are enough to compensate the targetted return and can cover the conversion losses. To minimize the conversion loss, the gold units will be converted only after the locking period. Thus rebalancing the portfolio to a better ackowledged 95:5.

            Enough with the idea. I want to actually test it with past data. If there is any benefit, then only I need to think more.

            If you could point me to the following details, it would be a great help.

            Daily/Weekly/Monthly gold price for last 10-15 years.
            Daily/Weekly/Monlthy NAV of any 2 good MFs to invest for last 10-15 years.

            If it is available as an excel sheet/txt file, it would be easy for me, rather than some link to check the NAV for each date.

            Thanks a lot for your support.

            Thanks,
            Paul

            1. Ramesh says:

              Your point regarding Ultra-conservatism somehow indicates that you are new in equity markets. No wonder, within our culture, it is so difficult to invest in equities without the mind-set of gambling and casino.

              Whether you like it or not, equity markets will go up and down. Be prepared. You cannot have the ups without the potential of downs.

              In any bull run, your strategy will fall flat. Consider, what if gold just goes on increasing, within 1-2 years, your 5 per month will fall down to 2-3 and will be negligible. You will also realize that gold and equities do not have a perfect negative correlation (no asset class combination has that. Even if it would have been, knowing that would have created effects leading to the disappearance of that effect).

              Point 6 is Asset re-allocation/re-balancing, which I do advocate.

              Regarding excel sheet data, create a portfolio in valueresearchonline, add monthly SIP of a gold fund and an equity fund since say 3-4 years back. Then you will have to manually put the details some more, but in the end, you should be able to get the transaction sheet as excel which you can use.

              Maybe try Mprofit, if that can do that for you.

          2. Paul says:

            Hi Ramesh,

            Thanks for the suggestions. I am new to Mutual funds and stock markets. But, I dont want to be late anymore.

            I will try value research online to get the necessary data.

            Thanks for all your efforts to teach us the personal finance. In fact, I came to know about personal finance from JagoInvester blogs/forum only. Keep up this work, and let everyone get benefited.

            Thanks again,
            Paul

  5. Dear Paul, what you are thinking is timing the market. In simple words, you ‘ll invest in Gold on a particular day as per your own calculation of market valuation & ‘ll revert back to Eq. on another day may be after some months or some years.

    As far as question of inverse relation, it’s not true always. Since 2003-2004, all the 3 major asset classes, Eq., Real estate & Gold have increased in valuation on a very high rate. So where is the inverse relation?

    I’m firm believer of KISS -= Keep it simple silly

    So like to make my investments that way only. Personally I’m not at all investing a single penny in Gold. Whatever gold is there in my house hold in the form of ornament of my wife dear (which is not at all investment in any sense & it;s there since my marrriage), is my only Gold exposure.

    No GOLD ETF, no physical gold, no Gold saving funds, no Demat Gold.

    I’m not asking you to follow me, just disclosing my side. 🙂

    Thanks

    Ashal

  6. Ramesh says:

    You are saying things which are quite correct.

    You are actually talking about the principles of Asset Allocation and Rebalancing. So read more on those.

    Yes, the correlation between equities and gold is not completely -1. There are lot many factors in there. Plus, even if it was -1 in the past, that correlation will not remain -1 in future. Hope, you understand the intention of the statement.

    Gold is at max a savings instrument and not an investment vehicle. In the last decade or so, it has acquired good returns because of loose monetary policies (at least the perception is that, whether that is true or not, does not really matter). It is not considered an investment vehicle because:
    1. It does not have any cash flow, now or in future.
    2. It is just a store of value, and because the “value” of govt backed money/currency is decreasing, the nominal value of gold is increasing. Will it do in future, we dont know.

    For reading purpose, I will ask you to go through http://www.bogleheads.org/wiki/Main_Page particularly regarding Alternative Investments.
    Go through the Lazy Portfolios page, and read what Mr Bogle and Mr Swensen have written about managing money. They have decent books too written in simple way. The principles remain the same, only their application from our country’s way will be different.

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