Gold is up!

Should I buy Gold as an investment?

Every now and then I get asked about gold as an investment. My view is that it is a speculative investment whose price is often driven up by fear and down by strong markets. You will have noticed some fear around recently I’m sure, and this has driven up the gold price to its current level of US$1,700 per ounce.

You may also be aware that the Australian dollar is currently very weak against the US dollar. So, if you are an investor in Australia and you hold gold, you have the added benefit of the currency rate further boosting your increase in investment value.So, if you bought gold in Australian dollars about a year ago you’d be pretty happy right now.

However, long term wealth creation requires your investments to perform well for decades at a time. When we build portfolios we adhere to a firm set of beliefs about long term market characteristics of a range of asset classes. Each asset class contributes something to the portfolio. Normally ‘growth’ or ‘stability’. We accept that risk and return are inextricably tied, so we balance the requirements of the client to build a portfolio that will perform at the highest level possible having regard to the volatility the client situation can withstand. Where possible, we take only the risk required to achieve the goal. Most of the assets we invest in also produce income in the form of dividends, rent or coupon payments. These inflows can be an income source for the client or be reinvested to compound our gains in the long run.

So, what is Gold’s role in all this? Is it a good growth asset?

Whilst, like any share or property, gold has periods where it’s performance well and truly beats the broader market, in the long run gold has performed poorly compared to other growth assets.

A long run chart below shows gold v global shares (growth assets) and Treasury Notes (defensive assets) over a 40-year period. As you can see, gold has not performed well compared to other growth assets.

So, perhaps gold is a defensive asset?

The only purpose for defensive assets is stability and liquidity. But gold has proven to be significantly more volatile than defensive assets such as Treasury Notes over a 30-year period with only a slight improvement in performance. It just doesn’t do what we need defensive assets to do. Couple the fluctuations in price with fluctuations in exchange rate and gold is much too volatile to hold as a defensive asset in the long run.

The graph below shows gold values in US and AUS dollars. As you can see, the exchange rate has a significant effect on the increases and decreases in value over time.

There’s another thing about gold. It doesn’t really do anything. It doesn’t produce anything, it doesn’t feed anyone, or cure anyone, it doesn’t pay an income in the form of a dividend or rent. Just under 80% of gold mined gets turned into jewellery. There is no question that is a growth area, with the significant majority heading to India and China. Nearly 20% ends up as bullion and only about 3% of gold goes into any form of technology, engineering or medicine etc. The only way gold as an investment will ever work for you is to buy it (at the right time), wait for it to go up and then sell it (at the right time), pay your transaction costs, pay your capital gains tax and then start looking for the next investment idea.

Summary

If you like the idea of owning a small amount of gold for a certain period of time as a speculative endeavour that’s great. If you got in three years ago and got out last week then you’ve done really well. But as a large component of a long-term investment portfolio we believe there are other, less speculative assets that will serve you better in the long run.

December Quarter Review

Economic Overview

The geopolitical risks that dominated for much of 2019 faded in Q4, supporting global share markets. Trade uncertainty faded with the US and China’s phase one trade deal announcement, while economic data remained stable. The trade deal, signed on January 15 means planned new tariffs will not be imposed, while US tariffs imposed in September on $120 billion Chinese goods will be reduced by half. The 25% tariffs on $250 billion of Chinese goods will remain. China also agreed to increase purchases of US goods, with agricultural produce highlighted.

The US Federal Reserve cut interest rates once in the quarter before indicating that “the current stance of monetary policy is appropriate”. The US economy expanded by 2.1% (annualised) in Q3. A result better than expected and stronger than Q2.

In the Eurozone, the confidence measure among German executives, improved in December, yet the Eurozone purchasing managers’ index remained unchanged at 50.6 in December – a level that indicates weak growth. Annual inflation was 1.0% in November, up from 0.7% in October but still well below the European Central Bank’s target of close to 2%. Christine Lagarde, in her first major speech as president of the European Central Bank, urged governments to boost public investment in order to increase domestic demand in Europe.

In the UK, the Latest GDP figures confirmed the economy had avoided entering a technical recession in the third quarter after contracting in the previous quarter. GDP growth was 0.4% quarter-on-quarter. Overall, the data suggests that the economy is coping with the uncertainty from Brexit. After the landslide election victory for the incumbent Conservative Party, the government is set to use its large majority to take the UK out of the EU by 31 January 2020, entering a transition period when the next stage of negotiations will begin

Japan’s economic data continued to show a significant divergence between the strength in service sectors and the weakness in manufacturing. There were also signs that the long-running trend towards an ever-tighter labour market had finally reached its natural limit. The main economic event for the quarter was the consumption tax increase on 1 October.

In Australia, the RBA cut the official cash rate to 0.75% in October. Despite predictions of further cuts, none eventuated during the quarter. Eyes now turn to the RBA’s first meeting in February. While the RBA noted in its December minutes that, “the Australian economy appears to have reached a gentle turning point” it also finished those minutes by noting, “the Board is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.”

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to the 31st December 2019

Overall, it was a mixed quarter to top off an extremely strong year. The majority of the Q4 gains came from global shares. US markets pushed higher as trade uncertainty faded, while Eurozone markets advanced with better economic data emerging from Germany. Bond markets reflected the better mood in the quarter as government bond yields rose (prices fell) and corporate bonds performed well.

Across the year it was hard to miss a good return, both Australian and global shares returned 20%+ returns, while Australian listed property was pushing 20% and fixed interest was given a shot in the arm as yields fell and prices increased. The asset class doing no one any favours? Cash.

In the US, the tech sector was a major beneficiary of easing trade tensions. Energy companies, which had lagged the broader S&P 500 index in 2019, rallied as the oil price rose on lower-than-expected supply.

Eurozone shares notched a strong return in the final quarter of the year, with the region’s MSCI EMU index returning 5.1%. Listed companies were supported by better economic data from Germany as well as the phase one trade deal agreed by the US and China. Gains were led by sectors that generally fare well when the economy is strengthening; top performing sectors included information technology, consumer discretionary and materials.

UK equities performed relatively well, and domestically focused areas benefited significantly as they responded favourably to the reduction in near-term political uncertainty.

The Japanese market rose in each month of the quarter to record a total return of 8.6%. Asia ex Japan delivered a strong return in Q4, supported by easing geopolitical risk as the US and China reached a phase one trade deal. US dollar weakness also provided support to returns. Against this backdrop China, South Korea and Taiwan all outperformed. In Taiwan, strong performance from technology sector companies boosted returns, as earnings expectations were revised upwards following solid Q3 sales figures

Emerging market shares posted a strong gain in Q4, benefiting from easing geopolitical concerns. The MSCI Emerging Markets Index increased in value and outperformed the MSCI World.

After a double digit first half of 2019, you might say the ASX coasted home with lower returns in Q3 and a meek 0.75% return for Q4. Notably, it did pass its previous record high in November. Q4 was hampered by a weak December with concerns over Christmas retail figures, the strengthening Australian dollar and improving employment figures, which paradoxically became a negative with the ASX counting on the support of further interest rate cuts. Meanwhile, three of the four big banks, NAB, ANZ and Westpac, struggled through Q4 with either more scandal or cuts to earnings and dividends, proving another drag for the ASX in Q4.

2019 Take outs

As we’ve noted, it was hard to go wrong in 2019, unless you had a bank account stuffed with cash or a poorly diversified portfolio stuffed with bank shares – or worse, a combination of both! Major asset classes all delivered stellar returns and when combined into a balanced portfolio of 60% growth assets/40% defensive assets the return was 16.74% for 2019, after a 1.01% return in 2018. Remarkably, the 2017 return for such a portfolio was 8.17% and the 2016 return 8.01%.

How reliable is that consistency? The average annual return for this portfolio is 8.27% for the past decade. The worst return came in 2011 with a -1.00% return, with 2019 being the best. Which shows if you’re prepared to ride out the sub-par years the realignment can eventuate, along with the rewards.

The on again off again trade tensions have proven somewhat farcical. A sniff of negative would take the market down and a whiff of positive would drag it back upwards. When the trade issues move into the background it will be interesting where global markets will take their cues from next. The US presidential race will likely be a focus. Just remember 2016 and the damage Donald Trump was supposedly going to inflict on world markets.

Whatever the focus, it should remain as a matter of interest, not a matter of concern. 2019 was a reminder that we should never react because our expectations may not align with market responses. There was significant concern as 2018 ended. Economic momentum was slowing, earnings growth was in question and optimism was low.

2019 returns were unexpected and more than anyone could hope for.

Does it mean anything for 2020? No. 2020 will have no memory of 2019, just as 2019 had no memory of 2018.

The Magic of Timing the Market

Lately the stock market has been the topic of conversation amongst many people. I have one friend who kindly always makes sure he tells me when someone gives him the tip that the stock market is about to crash. I always ask him “Could he please tell us what day, week or even month it is going to happen. I need to know when in order for it to be useful information”. I also explain that I will also need to know when it has reached the bottom, because I will need to know when to buy back in to reap the rewards from this information. So far, whoever is giving him the tips has been unable to provide the timing information that we need.

Buying investments or switching between different asset classes at the right time is very difficult. History has shown that doing it reliably and repeatedly is next to impossible.

There is a misconception that some people are “in the know” and can therefore buy low and sell high at just the right moment. What most people fail to appreciate is that each day an average of $450 billion of equity trading occurs around the world. The vast majority of this training is undertaken by stockbrokers, fund managers and analysts that are very much “in the know”. All these “in the know” people are competing against each other to make profits, whilst charging their clients for the work they are doing. Each time one outperforms the market, one under-performs the market by the same margin. That’s a mathematical fact. The net result is that half of the people “in the know” do better than the market and half of them do worse than the market in any given week, month or year. Ahaa!! I’ve got it! If we could work out which of the “in the know” people were going to beat the market this year we could make some great returns... If we knew that we would really be “in the know” wouldn’t we!

Unfortunately, research shows that the chance of any one particular money manager beating the market 5 years in a row is about the same as the chance of flipping 5 heads in a row with a coin (about 3%). And that’s before you factor in the fees that the money manager (quite justifiably) charges for doing his or her work. Factor in fees of just 1% and the money manager’s chances are well under 1%.

So I believe the best strategy is to deal with a manager with a good track record of regular, consistent flipping, but someone that charges you the least for each flip of the coin and you’ll do better.

There’s an issue of course. And the issue is that all money managers are doing it for a living and are trying to charge what they can. I do not begrudge anyone charging for their time and effort. So when our 1% miracle manager flips 5 heads in a row he (or she) tends to make hay while the sun shines, knowing that they may very well flip 5 tails over the next 5 years! So they charge a premium for their ‘proven’ coin flipping skills whist they can get it which reduces the returns for the investor even further. You can bet pretty safely that if you seek out the “best performing funds of the last 5 years” you will be paying a premium with no greater chance of success than if you just stick with the manager you used last year providing his or her fees are reasonable.

History has shown that the best way to get great returns is to invest across a considered range of assets taking into account your objectives, take a long-term view and focus on keeping costs low.

This means avoiding trading costs, avoiding realised capital gains and finding investments with efficient fees. It means having an overall strategy that reduces tax, harnesses the long term returns from the companies and properties of the world and manages risks.

Needless to say, that’s what we do here! If you’d like to deal with someone that generates income from great strategy and financial education rather than from selling any particular products or investments then we’d love to hear from you.