Week 21 - Gold

These days, i get a lot of questions about gold. There are those who wonder why it's doing so well and others who don't care and just want to know how to own it. We are reading more in the news and hearing more on the radio that gold is hitting new all-time highs each week. Normally, these types of conditions would lead me to believe that we are in a 'gold bubble' and that gold is overvalued at these levels. However there are still those that think gold can go higher.

In my opinion, the value of gold is affected by many factors, so I will try to explain a few of them as well as I can.

Supply & Demand

Economics 101, as they say. This is the simple theory that the price of something can increase if more people want to buy it, or if less of it is available for sale. It is difficult to predict supply (we have no idea how much gold is still in the ground) but most believe that because of the rapid economic growth in China and India, there are many more people wanting to buy gold than there used to be. Should this increased level of demand cause gold to increase from $200/oz to $1350/oz today? Again, difficult to say. That is some increase, though. There's an expression that might relate to this massive level of demand; that the Stone Age didn't end because we ran out of stones - things come along that might be viewed as better than gold or at least an effective replacement. This might not be likely with gold though because of its historical significance as the precious metal.

Gold as a currency

Many moons ago, gold was used as the standard for valuing one country's currency. That country might hold a level of gold in their reserves, which would serve to give their dollar (or pound, franc, etc) some value. The United States did this until the '70s I believe, but then declared that they were no longer going to relate the value of their currency to their gold reserves, which would allow the price of gold to appreciate or depreciate in U.S. dollar terms. Today, the U.S. dollar itself is known mostly as the world's 'reserve currency'; a country would value its currency vs. the U.S. dollar. Gold is also valued in U.S. dollars but with the tremendous fiscal deficits south of the border, many are wondering if gold itself is the only safe 'currency' to hold. Ironically, people have been saying this for years but in 2008 during the global economic meltdown, gold dropped in value significantly as investors rushed to convert their holdings into U.S. treasury bills (short term bonds); a telling sign as to where people still believe their money will be the safest. Still, many believe this story is far from over as nothing seems to be getting done about economic health south of the border. If things get bad enough in the States that their dollar depreciates rapidly, then many believe gold will still be looked upon as the 'new' safe haven.

Gold as a store of value - a safe haven?

That's where things get tricky. Right now many believe that governments around the world are struggling to keep the value of their currency low versus the U.S. dollar. America wants their dollar value down as much as possible because of how many foreign governments are holding U.S. dollar denominated debt. Why not just turn the money-printing presses on at home to make it easier to pay those governments off? That's pretty much what the U.S. has been doing and is also what China has been doing for years, to keep them in a competitive advantage as an exporting nation. In this case, one would think that gold, being priced in U.S. dollars, would stand to benefit.

I believe that like any currency, gold has to have a level of trust behind it. I don't want to hold my wealth in some measurement that has the potential to decline significantly in terms of my purchasing power. If it's going to cost me 400 oz of gold to buy a nice house today (about $520,000 CAN), then I don't want to risk the value of gold depreciating because people don't think it's worth that much. With paper currency, the health of the government and the level of inflation is really what helps maintain a reasonably consistent level of value. In Canada, we have a very healthy economy and therefore a strong dollar, relatively speaking.

Conclusion

I have a difficult time valuing gold for these reasons. Gold isn't a company. It can't win new contracts or increase productivity in the plant to help its stock price climb. The value of gold is based only on external factors that in my mind are extremely difficult to predict; currency movements, future supply and demand, U.S. economic health to name a few.

I have always kept my clients out of gold when they ask for my advice. So far, it has been an opportunity lost. But I'd rather look at it as a risk that I am not taking. There are other ways to store value that I view as safer today, in my opinion.

Week 20 - More on Stocks

It's been more difficult than I thought, coming up with things to write about. If you have any suggestions, feel free to pass them on.

Because of my general belief that stocks will yield the highest returns over time, I wanted to focus more on some ways that we can take advantage of this, and some ways that I don't think add value.

Buy & Hold

We remember the AIC ads from the late '90s which urged us to 'Buy, Hold & Prosper'. This is an age-old investment philosophy which focuses on the idea of buying stock in a number of companies and then pretty much just holding them for a very long time. Originally, I was a bit of a non-believer. However, more and more of my older clients would buy stocks back in the day and actually receive the certificates in the mail, which they usually stored in safety deposit boxes. Most of them never really cared what the market did; they just figured that they'd buy some stock in whatever company looked interesting when they had some spare cash. Now - say 25 years later - they deliver the shares which (so far, without exception) have substantially increased in total value. This doesn't mean all the shares are worth more but the ones that are have usually increased by a far greater amount than the bad ones have fallen.

I can't tell you how many times this has happened. The theory (whether these investors really knew they were doing this or not) was that over time, companies would either prosper or fail but the net result would be a gain. If you bought 10 stocks in the 1980s and even 2 of them were Canadian banks, then today, you probably have increased the value of your portfolio by about five times, even if a few of those other 8 stocks went bankrupt.

I don't think this is a bad investment strategy. It is certainly low cost, since once you own the stocks, you don't pay any fees. I think in general, people watch the market too much and it is too easy to buy and sell their stocks because of some external factor. It actually leads most people to stop buying stocks all together because they have no faith in the returns of equity markets. Actually, over the past 50 years, stocks in Canada have been far and away the best place to invest.

We don't see this result over the short term, however. All we hear about is how much debt the world has or what countries are still in recessions, etc. We end up just buying more house than we probably should and investing all our spare cash in paying down our mortgage. It isn't a bad strategy because if things get really bad, you can just live in your investment (unless your mortgage is a little too high - see the U.S. subprime crisis). We don't have a screen that tells us what our house is worth every day and we can't buy and sell houses by the touch of a button. So we naively think that real estate is a better performing investment. I suppose the next 50 years could be different than the last 50 years but I doubt it.

Buy and hold is advice that I think more equity fund managers should take themselves. As a portfolio manager myself, I feel the pressure of being compared to benchmark indices on a monthly or quarterly basis. It's totally counterproductive though because when I start buying stock in a company, I don't do it with the idea that I'm only going to hold it for a few months - exactly the same as when I'd buy a house. And yet, every month I want to see how my clients' portfolios performed against the index, instead of just sitting back and watching my portfolios grow, focusing on our country's best managed companies.

The polar opposite of buy-and-hold is day trading. The epitome of this is the commercial with the little baby who has opened up his online trading account so he can buy and sell stocks on a daily basis, trying to eke out a paper thin profit which he hopes will add up over time. In my mind, the ad represents kids who are putting a little money in an account to try and make it grow overnight. It is so much like gambling in this way because the only people that end up making money on this system with any guarantee are the brokerages that take a commission every time these kids do a trade. Want my advice? Focus more on finishing university, getting a real job and making actual money which you can invest properly.

The end message is probably that regardless of what side of the desk we sit on (investor or advisor/PM), we should probably watch markets less. They are great at giving us a meaningless number of what our companies are worth, when we have no near-term plans of selling.