Investors are Chasing Gold

November 9, 2010


As moths to a flame, investors are attracted to any asset class that is going up in price. Gold, which has returned an incredible 17.5 percent (average annual compounded return in US dollar terms) over the past decade, is not an exception to the herd-like behaviour of investors. The prospectus for the SPDR Gold Trust (GLD) (available here) includes a summary of world gold supply and demand data for the 2000 to 2009 period. The table clearly shows that demand for gold as an investment vehicle is exploding.

Jewellery remains the primary source of gold demand but the level of demand has fallen sharply in recent years. In 2000, jewellery accounted for 3,205 tonnes of gold demand but by 2009, it had fallen to 1,759 tonnes — a drop of almost half. Gold demand in industrial applications such as electronics and dentistry has remained fairly stable over the past ten years.

Investors can invest in gold either in physical form such as coins and bars or through exchange-traded funds (ETFs) such as the aforementioned SPDR Gold Trust (GLD). Demand for both sources are exploding — demand for coins and bars has increased from 166 tonnes in 2001 to 703 tonnes in 2009 and demand for gold ETFs have grown from zero to 617 tonnes.

[Investment demand for gold is exploding]

Update: You can find a linear gold demand chart here.

Why Gold Prices go up?

November 9, 2010


Gold is very much in the news these days with prices hitting fresh all-time highs seemingly every day. A recent paper by Dirk Baur of the University of Technology, Sydney, looked for empirical evidence of the factors that explain higher gold prices in data spanning the 1979 to 2010 time period (hat tip to Cameron Passmore of PWL Capital for highlighting this paper in a radio interview).

Highlights from the paper:

– Gold has acted as a hedge against a weaker US dollar and higher commodity prices.

– Gold prices increased when the short-term opportunity cost of holding gold decreased. Prices also increased when investors expected higher long-term inflation.

– Evidence for gold as an inflation hedge is weak.

– Gold acted mainly as a store of value against currency devaluations and commodity price changes until the mid 1990s. Since then, it has assumed an additional role as a safe haven — a hedge against stock market changes.

The paper is available here.

Past Performance of Gold Bullion

November 30, 2009


If you are interested in the past performance of gold bullion in Canadian dollars, you can find annual returns going back to 1970s in this spreadsheet on the Libra Investment Management website. The period between 1971 and 1980 was the golden decade — gold gained a total of 1759% in that time period or an astonishing 34% annualized rate. Since 1980, gold has gained just 50% in 29 years or a 1.5% annual rate. Most of that growth has been in the past decade in which gold has gained 140% or an annualized 9.14%. Year-to-date gold is up 16.75% in Canadian dollars.

[Gold Annual Returns in Canadian dollars, 1970-2008]

[Gold Returns Distribution for 1970-2008]

Some investors allocate a small portion of their portfolio to gold for diversification due to gold’s poor correlation with other asset classes. The data bears this out. The correlation between TSX Composite and gold bullion for the 1970-2008 time period is just 0.08. However, gold’s risk-reward profile leaves much to be desired. Since 1970 gold has returned 9% annually with a standard deviation of 29. By way of comparison, the TSX Composite has returned 9% with a SD of 17.

PS: The returns and standard deviation for gold were computed with the Upside / Downside Calculator available on the Stingy Investor website.