One of the old adage in the investing philosophy is to “Buy Low, Sell High“. Though it is well document by now as “Behavioral Gap” that most investors fail to do so and end up chasing the momentum with delay. Last week Gold has hit its life time high in INR terms to 4,800+ per gram, the returns over 1-1.5 years have been fabulous 40% or more. This recent run up has brought the questions about gold in every investors mind and rejuvenated the old love towards this asset class. If you have the same questions, today’s article might help you to decide the same.

What returns to expect from investments in Gold & at what risk?

I am a big believer that “Those who don’t learn from history are out to repeat it.” Gold has been the global currency for centuries and these is enough historical lessons to learn from it. Let’s look at the historical trend. In the last 40+ years trend of indexed gold price in INR terms as per world gold councils data has been phenomenal. Gold has grown by 73x with a CAGR of 10.9%. It has successfully proven itself a good hedge against inflation over these years.

The returns have not been linear and have come in cycles; a series of years with negative or low returns followed by higher returns. Below chart shows the Annual returns for each year since 1980 to 2020 YTD. The periods in circle can be very disheartening for investors to get away from gold as investment class, which was the case from 2012-2018. People have often started calling Gold as the dead asset and to be ignored.

Though that is not the case, as the gold is back with a bang and is all set to top the chart of returns among other asset classes for the second year in a row. (Check this) If the gold does not give linear returns then let’s look at its returns/ risk characteristics. The below table shows that the one year returns of the gold could be quite volatile and can be anything between -34% from 79%. Even though the mean returns range across the holding periods for 9-10% but the volatility reduces for the longer holding periods.

If you are a long term investor with buy & hold strategy and can stay invested for 15-20 years, go ahead buy the gold but be ready to get the returns of 3-4% or lower in such period.

Why should you invest in gold?

I did address this dilemma in my earlier article about Gold: to buy or not to buy!. Though the main idea can be summarized into two take-aways: 1. The gold is a good hedge against inflation/ currency risk and 2. Gold has a negative correlation with your equity investments so it can help you reduce the portfolio volatility. (Link)

To re-iterate and re-emphasize the point on negative correlation; It is not constant and it is increasingly negative over the last two decades. Let me share the below chart: it shows the correlation measured between the annual rolling returns of equities with annual rolling returns of gold. Data reviewed is from Jun 1999 to Jun 2020. the first point of correlation is measured for annual rolling returns of Nifty 50 TRI & Gold from Jun 2000 – 2010.

Can we improve our odds in avoiding the periods of negative or low returns?

As Howard Marks book “Mastering the Market cycles: Getting the odds on your side” iterates time after time that markets follow a cycle and if you can place the current situation on the cycle correctly, you can have an upper hand. Gold markets are one of the prime example of cyclical behavior. The cyclicity of the gold is also driven by the basic theory of economics.

The prices of gold are driven by the two main drivers supply of gold (Mined production or recycling) and demand for gold (as Jewelry, in Technology, by Central banks & by investors). If the supply of the gold is higher than the demand, the prices will stay flat or go negative and if the demand of gold is higher, the prices of gold increases. It is important to note that the supply of gold do not change drastically due to limited reserves and costlier & time consuming mining activities. That is one reason why the trend of gold prices do not change every year but is sticky for couple of years in a series. (Read more about supply & demand factors of gold)

To identify the gold cycle, I took the difference of 5 year return of gold vs 10 year return of gold to get the trend. The below chart can show you the peak & trough of the gold cycle. As usual the future returns are unpredictable but if you are towards the far bottom and the trend of returns change towards up, it is a good sign of +ve momentum for returns in gold. vice versa the reverse is also true. The main assumption in such methodology is that we will revert to mean over a long term.

In summary, the momentum is positive in the cycle and if the demand sustains then we are in for successive good period of returns in gold. You might have missed the initial leg but now we have similar chances of consolidation & get mean return (9-10%), higher than mean returns or lower than mean returns. Overall chances to get positive returns over next few years is still high.

Happy Investing!