Two months ago, when gold prices were on the rise, I had a conversation with Kristoffer Inton, director of equity research for basic materials, at Morningstar.
He said something that really gripped by attention. The current gold price is propped by investor demand—gold held in ETFs is at an all-time high. This is risky because today’s investment demand is tomorrow’s recycled supply when investors decide to pivot away from the safe-haven investment towards other investments.
Which brings me to a very pertinent question. As a valuation-driven investor, how must I value gold? Normally, one would buy assets that are demonstrably below a reasonable estimate of their fair value and enjoy the benefits of long-term cashflow generation.
What is gold actually worth? I reached out to Dan Kemp, Morningstar Investment Management’s CIO, EMEA. He was quick to assert that he does not consider gold to be an investment asset. “An investment asset is one which generates a positive cashflow to the owner and hence can be ascribed a ‘fair value’ through fundamental analysis. Prices move above or below this fair value in the short term. But over the long term, prices tend to move towards it providing a consistent measure against which its current attractiveness can be judged,” he explained. I get the point. There is no fair value to serve as a base to enable an investor make a buy or sell decision. At which price do you determine that gold is undervalued or overvalued? To add to it, gold generates a negative cashflow. Should you buy actual bullion, you need to pay for storage (like a bank locker) and insurance. Or, as Dan Kemp reminded me, the cost could also be due to the opportunity cost of lost income (interest if the value was held in a bank deposit or bond, or rent if it was commercial real estate). This reminds me of a quote by Warren Buffett that neatly encapsulates the views of Kristoffer and Dan.
Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything.
In a Fortune article in 2012, Buffett tackled the subject of gold as an investment. He first categorised investments:
Currency based investments
Investments in productive assets (businesses, farms, real estate)
Investments in assets that will never produce anything (art, gold, tulip mania in the 17th century)
So why are non-productive assets purchased? With the buyer’s hope that someone else will pay more for them in the future.
This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce — it will remain lifeless forever — but rather by the belief that others will desire it even more avidly in the future.
Gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. If you own one ounce of gold for an eternity, you will still own one ounce at its end.
What motivates most gold purchasers is their belief that the ranks of the fearful will grow. Beyond that, the rising price generates additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth — for a while. Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. At $1,750/ounce — gold’s price as I write this in 2012 — its value would be about $9.6 trillion.
Call this cube A.
Let’s now create pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge).
Can you imagine an investor with $9.6 trillion selecting cube A over pile B?
Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers — whether jewellery and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices.
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops — and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of cube A will compound over the century at a rate far inferior to that achieved by pile B.
As mentioned above in the article written by Warren Buffet, the price of gold early 2012 was $1,750/ounce; it is now around $1,683.
So what is the reason people narrow down on gold? Dhaval Kapadia, Director and Portfolio Specialist for Morningstar Investment Adviser India, looks at the most common reasons.
-Hedge against inflation: Traditionally gold has been viewed as a hedge against inflation and significant economic and financial market uncertainty. Currently, inflation isn’t a concern in most major markets and hence it’s role as an inflation hedge is limited. Hedge against depreciation
-Hedge against depreciation: Gold can act as a currency hedge. The price of gold is determined in international markets in foreign currency and converted to the price offered in domestic markets. Other things remaining the same, if the local currency depreciates vs the US dollar, the price of gold in the domestic market would rise.
-Interest rates: Gold tends to perform well in low interest rate scenarios as the cost of carry is low.
Summing it up While there are undoubtedly periods when gold performs very well and its inclusion would benefit the short-term returns of a portfolio, these periods tend to be unpredictable due to the lack of the fair value anchor.
Individuals have various claims as to why gold must be part of the portfolio. The aspects they really need clarity on is:
TORONTO – Strength in the base metal and technology sectors helped Canada’s main stock index gain almost 100 points on Friday, while U.S. stock markets climbed to their best week of the year.
“It’s been almost a complete opposite or retracement of what we saw last week,” said Philip Petursson, chief investment strategist at IG Wealth Management.
In New York, the Dow Jones industrial average was up 297.01 points at 41,393.78. The S&P 500 index was up 30.26 points at 5,626.02, while the Nasdaq composite was up 114.30 points at 17,683.98.
The S&P/TSX composite index closed up 93.51 points at 23,568.65.
While last week saw a “healthy” pullback on weaker economic data, this week investors appeared to be buying the dip and hoping the central bank “comes to the rescue,” said Petursson.
Next week, the U.S. Federal Reserve is widely expected to cut its key interest rate for the first time in several years after it significantly hiked it to fight inflation.
But the magnitude of that first cut has been the subject of debate, and the market appears split on whether the cut will be a quarter of a percentage point or a larger half-point reduction.
Petursson thinks it’s clear the smaller cut is coming. Economic data recently hasn’t been great, but it hasn’t been that bad either, he said — and inflation may have come down significantly, but it’s not defeated just yet.
“I think they’re going to be very steady,” he said, with one small cut at each of their three decisions scheduled for the rest of 2024, and more into 2025.
“I don’t think there’s a sense of urgency on the part of the Fed that they have to do something immediately.
A larger cut could also send the wrong message to the markets, added Petursson: that the Fed made a mistake in waiting this long to cut, or that it’s seeing concerning signs in the economy.
It would also be “counter to what they’ve signaled,” he said.
More important than the cut — other than the new tone it sets — will be what Fed chair Jerome Powell has to say, according to Petursson.
“That’s going to be more important than the size of the cut itself,” he said.
In Canada, where the central bank has already cut three times, Petursson expects two more before the year is through.
“Here, the labour situation is worse than what we see in the United States,” he said.
The Canadian dollar traded for 73.61 cents US compared with 73.58 cents US on Thursday.
The October crude oil contract was down 32 cents at US$68.65 per barrel and the October natural gas contract was down five cents at US$2.31 per mmBTU.
The December gold contract was up US$30.10 at US$2,610.70 an ounce and the December copper contract was up four cents US$4.24 a pound.
— With files from The Associated Press
This report by The Canadian Press was first published Sept. 13, 2024.
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.
The S&P/TSX composite index was up 171.41 points at 23,298.39.
In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.
The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.
The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.
The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.
This report by The Canadian Press was first published Aug. 29, 2024.
