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It has been awhile since I have written a post. But I am back now.

For those who follow the financial market through the Greek turmoil, it is hard to escape the fact that the gold price has plunged to a five year low. It is now trading at USD 1100 an ounce, a 42% drop since the 2011 high of USD 1900.30 an ounce.

I am not going to join the goldbug bashing train on this post, but I want to address some thoughts gold as an investment option. It is a normal occurrence during a drinking session at a local pub that someone would mention gold as a good investment. Here is what I am currently thinking of it. I hope that people would correct me if I am wrong.

What is investment?

Recently, I have been to a few interviews for an investment analyst position. One question I normally get is: what is the difference between investment and trading? To me, Cullen Roche summarised the purposes of investment very well:

Primary purposes for investing are:

1. Protect against the risk of permanent loss.

2. Protect against the risk of purchasing power loss.

Further, the timeframe for any average investor is generally long (like 10- 40 years until retirement). Trading, on the other hand, is about creating income right here and now. In the nutshell, the timeframes of the two strategies differ, even though the ingredient required for success may be similar.

Having this in mind is crucial in using gold as a major part of your investment strategy, because in the short time duration, the price movements is almost random, not truly reflect the underlying fundamental. However, in the longer timeframe, the prices “generally” move (or drift) in according to the fundamental. The real price for a share of a good company will generally move up over long period of time.

So, when talk about investing in gold, it is worth looking at its performance.

A Wealth of Common Sense had a recent post on a history of gold returns. His key message is this: investing in gold is highly dependent on the period you start investing in it as shown in the following table. And you won’t know until after the fact.

Source: A Wealth of Common Sense

Further, when you look at returns on investment for gold, it only yields 3.7 percent of real returns (compared to 7.0% for S&P 500), and you may have to endure two decades of negative real returns.

Source: A Wealth of Common Sense

This leads back to our discussion on the purposes for investing.

Gold can only protect against loss of purchasing power. It doesn’t protect you against permanent loss of wealth unlike investing in shares of stocks in a diversified portfolio. The risk for gold is that when most people don’t see it as an alternative form of money, its value is likely to collapse (Swiss referendum on gold reserve requirement of Swiss National Bank in 2014?). As Barry Ritholtz said repeatedly:

Gold is bought and sold based on a narrative that has turned out to be patently untrue.

And that, to me, means buying gold is mostly speculation, whereas you can get a fairly decent analysis on the discounted cash flow of any publicly traded company. In the other words, buying gold is a speculation on its value as currency. That is why brokers generally put it as part of forex trading.

So for me right now, gold belongs firmly in my trading strategies but not in my investment. This doesn’t mean gold cannot be part of a well-diversified portfolio.

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