Over a 210-year period, the after-inflation value of a U.S. dollar was a nickel. A dollar invested in gold became $4.52, in T-bills $281, in bonds $1,778 and in stocks $704,000, making stocks the runaway leader. (Jeremy Siegel: Stocks for the Long Run)
Despite this long-term track record, gold has a place in our portfolios because it tends to perform well when stocks have their periodic melt downs providing decent portfolio hedge benefits.
Opinions on gold run the gamut with many arguing it is important to guard against currency debasement and government malfeasance. I look at gold as a simple commodity, albeit one that marches to its own drummer. As a commodity, it responds to the rules of supply and demand. The price will go up when there are more buyers than sellers and down when there are more sellers than buyers.
Demand strengthens at times of economic uncertainty, war and inflation. Generally, gold will move in the opposite direction to the U.S. dollar but during the 2008/09 financial crises both strengthened as they were considered safe haven assets. Demand is influenced by central banks’ use of gold as a reserve currency, with India and China increasing their holdings substantially over the past decade. Central banks can also be gold sellers as occurred 10–20 years ago. Individual investors, jewelry, industrial uses, medical applications and technology are other sources of demand.
Gold miners create supply. It takes a long time, perhaps 20 years, between a new discovery and a mine coming into production, so there is no quick additional supply if demand surges. Despite significant exploration efforts, new discoveries have been waning.
Silver is more of an industrial metal than gold. The current price of silver is low when compared to gold. The historical average ratio is 50:1, but it would currently take about 90 ounces of silver to buy an ounce of gold. Most silver production is a by-product of gold and copper production, but there are some smaller silver-specific miners.
I used to buy shares directly in gold and silver mining companies but today prefer precious metal Exchange Traded Funds (ETFs). It takes too much time to understand a company’s reserves and costs. Gold miners often work in remote areas and jurisdictions with less than stable political regimes, and are subject to the vagaries of such regimes. I am therefore more comfortable owning the whole basket of gold or silver miners.
Two main U.S. gold ETFs are VanEck Vectors Gold Miners (GDX), which owns all the major gold miners, and SPDR Gold Shares (GLD), which owns physical gold. Over the past 15 years, GLD has grown by 250 per cent, whereas GDX is down 25 per cent. The gold miners have been poorly managed. That said, I own GDX rather than GLD because the miners seem to be getting their act together and there should be more upside to miners than the physical commodity. Owning both would be beneficial. A large Canadian ETF is iShares S&P TSX Global Gold (XGD).
There are also smaller silver-based ETFs, with Global X Silver Miners (SIL) owning a basket of stocks and iShares Silver Trust (SLV) owning physical silver. Since 2010, SLV is about flat, whereas SIL is down 30 per cent.
Despite these less than stellar results, precious metals play a role as they generally move in opposite direction to the stock market. If stocks are down gold is often up and vice versa. From 2007 to 2010 during the worst of the financial crisis, gold doubled. Another reason is psychological. One of the biggest risks to an investor is pulling the plug after a long decline, just before a rally. Having a few securities moving upwards could help you stay the course and stick it out until better days arrive.