Way back in the 2011 shareholder letter, legendary investor Warren Buffett explained why equities beat its alternatives hands-down. He especially argued against ‘unproductive’ gold. All the world’s gold stock melded in the form of a cube of 68 feet per side (he calls it pile ‘A’) remains unchanged in size over the years. That’s because gold does not produce any income, interest or dividends for its investors. However, pile ‘B’ created from its value could buy vast productive farmlands and stocks, which yield crops and dividends for its investors.
His memorable speech, however, fell on deaf ears. Ever since, the gold cube has grown to a larger size of 71 feet per side, thanks to a 15% rise in gold stocks. Recently, gold prices also hit a new six-year high of $ 1,452 per troy ounce.
Does investing in gold make sense?
First, let’s look at gold performance vis-à-vis that of equities, since 1979. In the last 40 years, Sensex has outperformed gold by a huge margin. While Sensex gave a CAGR of 15.9%, it was 10.2% for gold (in rupee terms). Moreover, Sensex returns would have been higher, if dividends of its constituent companies are factored-in to calculate its Total Return Index.
Unlike equities, gold investors have to cool their heels for a longer time. For instance, investors who had bought gold at the peak in 1980 would have had to wait for 27 more years just to see its prices get back to the same level. After discounting for inflation, they would still be waiting.
Depreciation Factor
Since 1979, Gold in dollar terms gave a CAGR of 4.5% as compared to 10.2% in rupee terms. Bulk (56%) of gold returns has come from depreciation of the rupee and not from appreciation of its intrinsic value.
While the period of 1999-2009 witnessed a relatively lesser contribution of the rupee depreciation factor, it was higher in the rest. In fact, during the period 1989-1999, but for the sharp depreciation of rupee, gold investors would have seen losses.
Long Waiting Period
Historically, gold prices have shot up during economic crisis or escalation of political tensions, thanks to its safe haven status. For instance, in 2008, when Sub-prime crisis rocked the world, gold prices were up by 29% as Sensex tanked by 52%.
Unlike equities, gold investors have to cool their heels for a longer time. For instance, investors who had bought gold at the peak in 1980 would have had to wait for 27 more years just to see its prices get back to the same level. After discounting for inflation, they would still be waiting.
Moreover, the odds of earning 10% plus returns were higher at 66% for Sensex as against 43% for Gold – for an investor with a five-year investment horizon, assuming investments are made in the beginning of the year. For 10 years, such odds increased only by a little to 47% for Gold as against 77% for Sensex.
A good cause
India is the second largest consumer of gold owning about 12-13% of the world’s gold stock. If India’s gold stocks were to even partially find its way into financial savings it could be productively channelized towards the real economy. Infrastructure and social sectors like health care desperately need funds which could be funnelled from financial savings of the households.
Takeaway
All said, equities have outperformed gold by a huge margin. Moreover, gold has earned bulk of its returns from rupee depreciation and not from appreciation of its intrinsic value. Investors are therefore better off treating gold as a small part of their portfolio to ensure it doesn’t impact long term growth.
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