Commodities are a relatively poor investment

2008-01-29

in Economics

Pool table

For a collection of reasons, the world is experiencing a commodity boom. Oil is hovering around $100 a barrel, while gold and platinum are setting new records. That said, it is still questionable whether commodities are a good long-term investment. While they boom sometimes, there will also be times when a glut or changes in demand cause prices to plummet.

Looking at the trends from 1985 to present, you can see a sharp divergence in asset performance between different classes of investment. The average dollar invested in global real estate in 1985 would be about $7.50 today. An investment in stocks would have yielded about $6.50, while bond growth would have left you with about $4. Investing in a basket containing all traded commodities would have yielded a return of about $2.60, while investing in just oil would have yielded less than $2.00 (oil having seen sustained growth in price only since 1998 or 1999).

None of this is to say you can’t make a fortune trading commodities. It just suggests that if you want to put money away for a few decades, not think about it much, and live well off it later, investing in equities is the way to go. Given the costs of management versus the extra returns, it is probably best to invest in index tracking funds, but that’s an issue to comment on another time.

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{ 16 comments… read them below or add one }

R.K. January 29, 2008 at 1:21 pm

These things are a lot simpler when one is in debt. Paying it off is usually the best form of investment.

Neal January 29, 2008 at 1:15 pm

If you invested in the DJIA in 1929 and held onto it, it would take until the 1950s before you broke even in nominal terms. Personally, looking at that graph, bonds look like a better choice than stocks or real estate, but even then, what happens to the bond markets if the big bond insurers go under?

To paraphrase someone on Metafilter, these days, baroque financial instruments are making it increasingly hard to tell where real assets lie, and who’s holding a bag of exploding lepers.

. January 29, 2008 at 4:17 pm

If Donald Trump had taken the millions he inherited from his father and put it all into mutual funds, you’d never have had to suffer through one of his books. But he’d be just as rich or richer today.

Common stocks have returned an average of 7 percent per year, adjusted for inflation. If you are way smarter, luckier, and less risk-averse than all of the companies in the United States, you may be able to do substantially better. But a return on investment of 200 percent per year is not very exciting when you only have a few hundred dollars in capital. That’s why it is so important to pick your parents carefully.

Milan January 29, 2008 at 5:04 pm

If you invested in the DJIA in 1929 and held onto it, it would take until the 1950s before you broke even in nominal terms.

Right before the Great Depression was admittedly a bad time to invest in stock. When holding stock, rather than something like Guaranteed Investment Certificates, you are betting that the risk of such catastrophic stock market declines is adequately compensated by the difference in interest rates between the assets. Over a long enough time period, this is highly likely to be true.

[B]aroque financial instruments are making it increasingly hard to tell where real assets lie, and who’s holding a bag of exploding lepers.

There is some truth to this, but I am still willing to bet that a dollar invested today will be worth the most in 20 years if it is invested in a low-fee index tracking fund of global equities.

tristan January 29, 2008 at 6:39 pm

If you invested in Gold on september 13th 2001, which at the time I thought of as a good idea, it appears one would have done quite well.

Neal January 29, 2008 at 6:43 pm

Hindsight is 20/20, and I think gold is wildly overvalued right now. That said, I’m not willing to put my money where my mouth is.

Milan January 29, 2008 at 7:04 pm

Tristan,

Over certain spans of time, it is inevitable that individual commodities will experience big changes in price. What I was describing above is multi-decade investment strategies.

It would be interesting to have the same trend lines as those linked running back to 1900.

R.K. January 30, 2008 at 1:53 pm

Does this mean that the average value of a commodity has increased 2.6 times since 1985?

. April 20, 2009 at 4:36 pm

Gold versus shares

Posted by:Buttonwood

AN EARLY post on this blog compared gold with index-linked gilts, and showed that the latter asset had performed better since its inception. But the more common comparison is between gold with shares.

The last market.view column on this website compared gold with the Dow Jones Industrial Average. Some suggest that this ratio, which flirted with parity back in 1980, might be heading back there. Given that the Dow is hovering around 8,000 and gold is around $900, that would mean a lot of downside for shares or upside for bullion.

But it seems more likely that shares ought to exhibit a long-term upward trend relative to precious metals. After all, equities should be correlated with GDP growth, gold with inflation. Research by Dave Ranson of Wainwright Economics suggests that this uptrend (dating all the way back to 1814) is around 1.5% per annum.

. July 26, 2010 at 6:11 pm

Gold
Store of value
Low returns on other investments and fears about the world economy have caused the price of gold to soar. Don’t count on its continued rise

Jul 8th 2010 | Delhi and london

ON THE kind of hot, sultry day in which the brutal Delhi summer specialises, the attractions of lingering languidly over gold jewellery in air-conditioned comfort are easily understood. Yet customers are thin on the ground in the jewellery section of the Central Market, an unruly hive of commerce in the middle-class district of Lajpat Nagar. “Business has never been this slow in the 14 years that I’ve run this place,” complains Mrs Anand, owner of Hans Jewellers. Lajpat Nagar’s jewellers estimate that sales are down by 40% or more on a year ago.

In a typical year India soaks up perhaps a quarter of all the gold mined in the world. Now, however, not only are people not buying; more and more of them want to swap their gold jewellery for cash. Jyoti Pal, a shop assistant, reckons that these days about as many people come in to sell as to buy. Suresh Hundia, president of the Bombay Bullion Association, goes further: “There are only sellers in the market at these prices and most jewellers are buying back only old jewellery.”

Middle-class Indians have been turned from buyers to sellers by the rapid increase in the price of gold in the past couple of years. The seemingly insatiable demand of mainly Western investors, drawn to gold as a store of value rather than as an adornment, has driven the price from less than $700 an ounce in 2007 to more than $1,200 since May this year. Last month it reached its highest-ever point in nominal terms, $1,264.90. It has eased a little since, sliding below $1,200 this week. After adjusting for inflation (measured using American consumer prices), in recent weeks the gold price has been at its highest for 30 years—although only just over half its all-time high (see chart 1).

In both the Central Market and the international financial markets, there is no shortage of people who believe that the price will resume its ascent. Ronald Stöferle, an analyst at Austria’s Erste Group, points out that the value of American gold holdings amounts to about 1.85% of the country’s GDP. In 1940 it was above 20% and in 1980 close to 7%. This, he argues, points to continued demand for gold from investors. He expects the gold price to hit $2,300 by 2012.

The appetite for gold arises partly from the paltry, uncertain returns from more conventional investments. Gold’s main drawback is that it pays neither a dividend, like a share, nor a coupon, like a bond, nor a rent, like property. But monetary policy has been keeping official interest rates, and thus the opportunity cost of holding gold, low and seems set to do so for a while. The yields on the government bonds investors regard as safest, notably America’s and Germany’s, are also thin. Equity markets are weighed down by worries about economic growth. Investing in property, which lay at the root of the financial crisis, requires a boldness that many still lack.

At the same time, the looseness of monetary policy has made many investors fear the eventual resurgence of inflation. The wretched state of many governments’ finances makes some worry about states’ ability to repay their debts—or about the temptation to inflate them away. Banks’ exposure to sovereign debt and to a still-fragile world economy adds another layer of concerns. And when all governments would like their currencies to be weaker rather than stronger, whose paper money do you trust? Hussein Allidina, head of commodities research at Morgan Stanley, reckons: “Gold looks better every day with growing sovereign risks.”

. June 7, 2011 at 5:42 pm

SIR – Buttonwood discussed the possibility of gold as a bubble (April 30th). Of course it is—it has almost no real value and, as you say, no revenue or cashflow. It is an iconic commodity both emotionally as jewellery and intellectually as a stable investment, and has long been a guiding point for commodity inflation. But what gives it that place?

Gold has few uses beyond jewellery, and yet the trading of gold internationally is many times larger than that industry. Today it, like a share with no dividends, is a purely speculative investment and its value is entirely a function of such speculation. A high gold price does not cripple an industry or a nation; the current owners just get richer. A currency with a constant influx, the rise in value of gold is like a great Ponzi scheme where the future must always pay today’s bills.

Commodities with stable consumption and high volume production (like wheat and iron) are better indicators of real prices and as they continue to rise inflation is a risk. Gold is different. One day the money will dry up, and the house of cards will fold.

Nils Sandberg
Judge Business School
Cambridge

. February 15, 2012 at 11:22 am

Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce — gold’s price as I write this — its value would be about $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers — whether jewelry and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices.

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops — and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil (XOM) will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

. May 17, 2012 at 11:26 am

Gold’s hasty demise from safe haven to risky asset

https://www.theglobeandmail.com/globe-investor/investment-ideas/david-parkinson/golds-hasty-demise-from-safe-haven-to-risky-asset/article2435140/

From darling to whipping boy, risk haven to risky business.

Gold (GC-FT) took another wobbly step in its steep descent Wednesday, shedding $16.80 (U.S.) to $1,540.30 an ounce in New York, as Greece’s political uncertainties once again spooked financial markets. It was the metal’s 11th decline in the past 13 trading sessions, during which time it has lost more than $120.

. December 21, 2013 at 10:04 pm

Investing in commodities
Rust-proof
Despite a tarnished record, commodities have not lost their lustre for all

. January 27, 2014 at 4:24 pm

The Swiss National Bank said that the value of its gold reserves fell by SFr15 billion ($17 billion) in 2013. Gold prices tumbled by 28% last year, the steepest annual drop since 1981, ending a 12-year bull run for the precious metal as investors instead piled into booming stockmarkets. Switzerland’s central bank holds more than 1,000 tonnes of gold. America holds the largest amount of gold in the world, around 8,100 tonnes.

. April 25, 2017 at 1:44 pm

AMERICA has bombed Syria, and its relations with Russia have deteriorated. North Korea is developing a long-range nuclear missile, a development which Donald Trump has vowed to stop, unilaterally if necessary. There is talk of a “reflation trade”, with tax cuts in America pepping up global growth.

All this ought to be good news for gold, the precious metal that usually gains at times of political uncertainty or rising inflation expectations. But as the chart shows, gold took a hit when Mr Trump was elected in November and is still well below its level of last July. As a watchdog, gold has failed to bark.

The problem with gold is that there is no obvious valuation measure. The metal pays no real “earnings”. Although gold is seen as a hedge against inflation, it cannot be relied on to fulfil this function over the medium term; between 1980 and 2001, its price fell by more than 80% in real terms.

So buying bullion is really a bet that things will go spectacularly wrong: that events escalate in the Middle East and North Korea or that central banks lose control of monetary policy. It could happen, of course, but it helps explain why gold bugs tend to be folks with a rather gloomy attitude towards life.

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