The Not-So-Glittering Story of Gold Investing

Do you remember the craze for gold as an investment option only a few years back during the earlier parts of the 21st century’s second decade? I do.

Back then, as I remember it, most investment forums I visited will have a forum participant talking about investing in gold. The discussions that followed those posts were also lively and engaging, with many participants asking questions, signaling their interest in investing in the precious metal. This was in 2011.

As gold prices climbed from around US$1,300 an ounce at the start of 2011 to a high of almost US$1,900 late that year, there was talk of gold going to US$2,500 per ounce and beyond.

The investment thesis for gold at that time was that it’s a “safe” investment, something which wouldn’t lose you money. I even recall a meeting I had with a senior manager from the branch of a reputable international bank who drew a chart of the price of gold for me, pointing out that the precious metal’s price had gained 20% per year over the past five years. With the trend going strong, I can look forward to 20% returns over the next five years as well, said the manager.

Sadly, by the end of 2013, gold had fallen to around US$1,200 per ounce in price. With the aforementioned euphoria in the precious metal in earlier years, it’s likely that many investors had been badly burned. Yet, ardent proponents for the precious metal as an investment option were still legion.

This time around the investment thesis was that the production cost of gold in many gold mining companies was around US$1,200 an ounce, therefore, it is unlikely that the precious metal would fall below its production cost.

It’s a flawed thesis. Thing is,  the history of most commodities have showed that prices do fall below production costs. If there is too much supply for a product, the price of the product will fall and those producers who are producing at high costs would have to shut down their operations. Yet at that time, many saw the production cost argument as something logical.

We’re now in 2015 and interest in gold-investing seems to be waning with the price of gold lingering near the US$1,100 mark.

What does the story of gold tell us? There are two important takeaways, in my view:

  1. There is no such thing as a “safe” investment class. Safety is a function of the price that’s paid relative to the value of the asset (which is in turn determined by the profit and cash flows that can be produced by the asset). This is why valuation and the concept of margin of safety can be an important part of one’s investment thesis. In the case of gold, which by itself does not produce anything, valuing it can be tricky.
  2. What is cheap can get cheaper. Gold fell to its production cost in 2013, but that did not prevent a further fall.  The prices of commodities can be very volatile and can fall to levels that do not make economic sense for its producers. It pays to be aware that such developments have happened in the past.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any companies mentioned.