Gold glitters for some

Yesterday the question was put to me twice; "is it not worth holding a small part of your portfolio in gold for the times when the market drops?"


The argument for holding gold is that when things go badly in the world, people get scared and gold becomes their safe haven. If people feel good buying gold the price of gold shouldn't drop much and by extension the gold shares should do comparatively well, therefore hedging yourself against adverse market conditions.


Due to my economics background the first thing that I ask myself; "What is the opportunity cost of holding gold?" In order to test what the opportunity cost would be of holding gold, I decided to compare where you would be today if you bought Anglo Gold compares to Woolworths exactly 7 years ago. The reason for choosing Woolworths is because it is also considered a form of defensive stock, due to it being in the retail space.


Something that surprised me was that Anglo Gold dropped 56% from its 2008 high to low, but then QE was announced and it recovered 73% of its losses in about a month. The problem with the 56% drop is that the theory of gold being a hedge against adverse market conditions, sort of looks untrue? The difference between Woolworths high and low in 2008 was 61%, so gold wins the battle of not falling as much, just.


The more important stat is that over the 7 years, your investment in gold would now be down almost 60%, ouch! On the other side your Woolworths position would be up around 355%. Even if a nuke went off in New York tomorrow sending shockwaves around the world and Woolworths went down by 61%, and Anglo Gold doubled in price. Even in that extreme case, the Anglo Gold position would still be down 18% and Woolworths up 77% over the 7 years.


If you think that the world is going to end or if you like the glint of gold, then rather buy the commodity itself. That way you make money when the spot price goes up and you don't have the problems/risk of labour unrest, unprofitable mines or any other risk that is attached to a Gold mining company.


The problem with buying a stock for the bad times, is that the bad times are temporary, things recover and then become better than they were before. As an investor, your time horizon should be forever or at the very least 5 years. In that time there will be a crisis or two and your portfolio will go down by +30%, but that is only a problem if you are selling during a crisis. Your horizon should be further than the crisis and such making a crisis a no event in the life of your portfolio.