Gold is riskier than Stocks!

A few weeks back, an article in a mutual fund distributor’s blog caught my attention. The article listed the price of 10 gms of gold from 1925.

The author wanted us to observe the huge increase in gold price from 1925 (Rs. 18.75) to today Rs. 29,190 (average price of FY 2013-14). It was therefore concluded that investment in gold can never go wrong and the price was always bound to increase! To access such articles search for “gold price India 1925”

In this post, let us stare at some historical gold and stock market returns. You might just about be convinced that buying gold as an investment is riskier than buying stocks!

As an investment, mind you, and not for consumption or as hedge against hyperinflation during war and economic collapse

We will look at two groups of data:

Group A

  1. Gold price in INR (10 gms) from 1925 (source) (Original source is supposedly RBI but I am not able to locate it)
  2. Gold price in USD (1 troy ounce = 31.1034768 grams!) from 1925 (source)
  3. US stock index S&P 500 (CNX 500 can be thought of as an approximate analogue?) data from 1925 (source)

 Group B 

  1. Gold price in INR (10 gms) for each FY since 1972-73 from RBI
  2. Sensex data from 1979-80 (Subra shared privately)

The nature of the groups should be self-evident. The first group analyses data from 1925 to present and the second group from the 1970s to the present.

S&P 500 and Gold price in USD as available from 1871 and 1850 respectively! I truncated the data set at 1925 to match the starting date of the INR gold price data.

Before we begin, an interesting quote from nma.org

The price of gold remained remarkably stable for long periods of time. For example, Sir Isaac Newton, as master of the U.K.  Mint, set the gold price at L3.17s. 10d. per troy ounce in 1717, and it remained effectively the same for two hundred years until  1914.  The only exception was during the Napoleonic wars from 1797 to 1821. The official

U.S. Government gold price has  changed only four times from 1792 to the present. Starting at $19.75 per troy ounce, raised to $20.67 in 1834, and $35 in  1934. In 1972, the price was raised to $38 and then to $42.22 in 1973. A two-tiered pricing system was created in 1968, and  the market price for gold has been free to fluctuate since then.

 Method:

We will look at long term returns from gold – 5Y, 10Y, 15Y, 20Y and 25Y. Suppose we have data from 1925 to 2013, and would like to determine 5Y returns (CAGR), we use,

CAGR = (price-after-5Y / initial-price )^(1/5) -1

The CAGR is determined for every possible 5 year period (1925-30; 1926-31; 1927-32 and so on).

The average of all such returns is calculated along with the standard deviation.

This is repeated for the other durations – 10,15,20 and 25 years.

The standard deviation is a measure of how much individual returns deviate from the average. Higher this number, more the variation.

The idea is to understand how much the returns have varied for different periods and for a given period, the amount by which individual returns can vary.

So let us begin,

Results: Group A

Let us start with the gold price in INR from 1925

gold-1

Now for the gold price in USD from 1925

Gold returns USD

  •  Notice that, while there is not a huge difference in returns for change durations, the standard deviation is larger for lower durations.
  • This means, lower the duration, higher the deviations from the ‘average’. That is, the risk of attaining a return close to the average is higher for smaller durations

To understand this better, have a look at how the 15 year averages have evolved

Gold is riskier than stocks

Notice the wave like nature of the returns. They seem to be moving away from the tilted black line and heading back to it. The red line represents the ‘average’ of the data set. The extent of deviation from this red line is given by the standard deviation.

Sometimes investors end up with returns higher than the average and some other times lower than the average.  For the purposes of this article we will refer to this risk. In reality it represents volatility  and not risk. The title of this post should actually read, Gold is volatile than stocks!

Now let us get back to comparing the above tables,

  • Notice the difference in returns between INR and USD gold prices. Can we assume this stems from the INR:USD conversion rate? Seems to be so (do correct me if I am wrong).
  • The fall in INR standard deviation (risk) with an increase in duration is higher than that for USD standard deviation.
  • This means, the risk associated with buying gold in USD is much higher than for INR. Almost twice as high! This can be inferred by looking at the ratio of standard deviation/return
  • When people sell gold as an investment (etfs, fund of funds, e-gold), they say, ‘gold is a hedge against inflation’. Do you think returns from gold after taxes has beat inflation whether the purchase was made in INR or USD?

Now let us look at the corresponding numbers for S&P 500 stock index

S&P 500 returns

  •  Do not let the higher returns bother. Stocks have always returned higher than gold. Even the most hard-core gold fan knows this.
  • Focus instead on the fall of the standard deviation with increase in investment duration and the std. dev./return ratio. Both of these represent the associated risk.
  • Would you believe that the risk associated with investing in US stocks is one-half of that associated with buying gold in USD for 5,10 year durations?!
  • The US stock-risk is one third of the gold-risk (USD) for 15,20 year durations and one-fourth for 25 year durations!!
  • The US stock-risk is also significantly lower than the gold-risk(INR) although the comparison may not be appropriate.

 Results: Group B

Now let us look at similar data for Gold price in INR (10 gms) for each FY since 1972-73

Gold Returns RBI

Now for Sensex data

Sensex returns

  •  Investing in gold for 5 years is about 20% less risky than stocks. Nothing to shout out though!
  • For higher durations, the risk associated with gold investment is higher and is more than twice that of stock investments for 25 year periods!

Let us remind ourselves that risk in the present context refers to the extent of deviation from the average return for a given duration.

Even if we don’t look at exact numbers and point out, group B data suggests that gold investing is as volatile as equity investing, it would still be news to our largely gold mad population who shy from stocks thinking that they would lose their capital. Such people should go and check the performance of gold ETFs and gold funds in the last two years.

What of it? 

The volatility associated with gold returns is not worth it, considering the quantum of reward associated for any investment duration.

Add to this the fact that long-term capital gains from gold etfs and golds funds will be taxed like debt mutual funds (10.3% flat or 20.3% with indexation benefit), gold is not at all an appealing investment.

Should not gold be part of a diversified portfolio?

Well the reason people say that in the first place is because of this

Gold stocks correlation

Notice the negative correlation between gold and stocks. So if gold is part of a well diversified folio (equity, bonds and gold), it can lower the volatility of the net portfolio.

However, in a developing country like ours, where interest rates are high and rewards from equity are much higher than inflation, choosing 65:35 (equity:debt) asset allocation like an equity oriented balanced mutual fund is all one needs to get good returns with low volatility.

Typically including a volatile asset in the folio poorly correlated with existing assets lowers the volatility of the portfolio (counter-intuitive!).

However, if we overdo it, we will end up lower returns. We will also not be able to gain from a market rally like the present one.  This is the disadvantage of too much gold in the folio – keep an eye on the performance of funds listed under Hybrid: others category in VR online.

For example, here is how SBI Edge fund which holds approximately equal proportions of equity, debt and gold, fared since 2003

SBI-edgeNo volatility, but no performance either! The fund no longer exists.

What about the 10% gold allocation that ‘experts’ recommend via ETFs and fund of funds?

ETFs are not the clean product that most of us think they are. See here and here  (Links from facebook group, Asan Ideas for Wealth). Google for ‘gold ETF scandal’ to become uncomfortable with ETFS!

I think with equity and debt allocation with year rebalancing and some tactical calls, most of us manage to contain portfolio volatility and get decent returns without gold.

What do you think?

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23 thoughts on “Gold is riskier than Stocks!

  1. Raghu Ramamurthy

    I had indirect investment with gold through ETF about 3 years back and made an exit after a year.So I an NOT an advocate for Gold. However,the comparison between Gold and Sensex in my opinion is not correct. Gold is a single product.Sensex consists of 30 companies.During the period of from 1925 to date the composition of Sensex companies and their weights have gone for a big change. So it would be of interest to compare the price of Gold with the share price of any Company which continues to exist from 1925 todate.Or we can alter the base year from 1925 to, say 1950.

    Reply
  2. Raghu Ramamurthy

    I had indirect investment with gold through ETF about 3 years back and made an exit after a year.So I an NOT an advocate for Gold. However,the comparison between Gold and Sensex in my opinion is not correct. Gold is a single product.Sensex consists of 30 companies.During the period of from 1925 to date the composition of Sensex companies and their weights have gone for a big change. So it would be of interest to compare the price of Gold with the share price of any Company which continues to exist from 1925 todate.Or we can alter the base year from 1925 to, say 1950.

    Reply
  3. Raghu Ramamurthy

    To continue,even share prices of individual companies have to be adjusted for bonus,stock splits etc.
    Perhaps the comparison could be Gold vs Mutual Fund Growth option. Here the period of comparison will be about 12 Years only as I think the first equity oriented MF was started in India about 12 Years back.

    Reply
  4. Raghu Ramamurthy

    To continue,even share prices of individual companies have to be adjusted for bonus,stock splits etc.
    Perhaps the comparison could be Gold vs Mutual Fund Growth option. Here the period of comparison will be about 12 Years only as I think the first equity oriented MF was started in India about 12 Years back.

    Reply
  5. Pattabiraman Murari

    We have UTI mastershare which was started in 1986. While using S&P 500 I am assuming the use of an index ETF compared with a gold ETF. There have small tracking errors with low expenses and is a fair comparison in my view. The key observation is the standard deviation is too large to be ignored. People thing gold prices keep increasing unmindful of the volatility.

    Reply
  6. Pattabiraman Murari

    We have UTI mastershare which was started in 1986. While using S&P 500 I am assuming the use of an index ETF compared with a gold ETF. There have small tracking errors with low expenses and is a fair comparison in my view. The key observation is the standard deviation is too large to be ignored. People thing gold prices keep increasing unmindful of the volatility.

    Reply
  7. Alok Jha

    Sir, investment in gold is worthy because of its negative correlation with equity. It is a very helpful in tactical asset allocation.

    Reply
  8. Alok Jha

    Sir, investment in gold is worthy because of its negative correlation with equity. It is a very helpful in tactical asset allocation.

    Reply
  9. Sanjiv Singhal

    Hi Pattu.

    My colleague Ravi did a similar analysis and came up with pretty much the same conclusions:
    1. Gold price has appreciated by 6.6% pa in USD terms and 9.9% pa in rupee terms over the last 6 decades.
    2. While this rupee return is reasonable and beats inflation, the return (as you've pointed out) comes with large volatility. In the past 6 decades, gold was a super star asset class in 2 decades, a complete disaster in 3 decades and just about managed to pass the test in the remaining one decade.
    3. About half of the return of gold has come from rupee depreciation and not from gold as a precious metal.

    Our analysis is here https://scripbox.com/blog/does-investing-in-gold-make-economic-sense/

    I personally don't think investing in gold (5% or 10%) makes sense. There is little diversification benefit if it's such a small component of your portfolio. PPF or debt funds give much the same return with much less volatility.

    Sanjiv

    Reply
  10. Sanjiv Singhal

    Hi Pattu.

    My colleague Ravi did a similar analysis and came up with pretty much the same conclusions:
    1. Gold price has appreciated by 6.6% pa in USD terms and 9.9% pa in rupee terms over the last 6 decades.
    2. While this rupee return is reasonable and beats inflation, the return (as you've pointed out) comes with large volatility. In the past 6 decades, gold was a super star asset class in 2 decades, a complete disaster in 3 decades and just about managed to pass the test in the remaining one decade.
    3. About half of the return of gold has come from rupee depreciation and not from gold as a precious metal.

    Our analysis is here https://scripbox.com/blog/does-investing-in-gold-make-economic-sense/

    I personally don't think investing in gold (5% or 10%) makes sense. There is little diversification benefit if it's such a small component of your portfolio. PPF or debt funds give much the same return with much less volatility.

    Sanjiv

    Reply
  11. Alok Jha

    Pattabiraman Murari Sir, what if the Sensex was sold in 2007 and gold was bought and the same was reversed in 2009. The asset is multiplied 13 times in 7years!

    Reply
  12. Alok Jha

    Pattabiraman Murari Sir, what if the Sensex was sold in 2007 and gold was bought and the same was reversed in 2009. The asset is multiplied 13 times in 7years!

    Reply
  13. Navneet

    Pattu nowadays taxation of debt schemes is 20.6 after availing indexation. 10.3 has been withdrawn since July 2014.

    Reply

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