In times of economic uncertainty, the decades-old debate surrounding investing in gold inevitably resurfaces. For example, as the world awaits the still unknown consequences of the Brexit vote, many nervous investors may be tempted by the lure of gold—that mythic yellow element that has captured the psyche of mankind for millennia. Lest we forget the cautionary words of J.R.R. Tolkien, All that is gold does not glitter, it is worth considering the often illusory and provisional qualities of gold. Despite being the most popular of all precious metals as an investment, there are several reasons why we at Mawer do not invest in gold.
Our main concern with gold has always been valuation. Historically, it has served as a medium of exchange and a store of wealth. It’s not the original medium of exchange—many things have been used as money throughout civilization, from seashells to giant obelisks—but gold, perhaps more than anything, has long stood as the universal symbol of wealth. Today we’re seeing another evolution in money in various cryptocurrencies such as bitcoin. It raises the same fundamental question that gold does: what is it really worth? Whatever the valuation, just as with gold, it’s always speculation.
The appeal of things like gold and bitcoin may stem from the idea that they are inflation-proof because they’re not controlled by some other party that could produce more quantities of each at any given time. That would be the knock against many of the current fiat systems; central banks can print money and deflate its value, thereby decreasing its purchasing power. That’s a good reason not to keep physical money under your mattress—it will have less purchasing power with the passage of time.
But gold’s price—like that of any other precious metal or commodity—can fluctuate dramatically. The decline in the price of gold from more than $800 per ounce in the 1980s to less than $350 per ounce in the 1990s is a well-known example. But the most significant variable influencing gold’s price is the amount of it held by the world’s central banks. According to the World Gold Council, as of 2011, central banks collectively held approximately 17% of the world’s gold and have continued to amass it at record rates. And the central bank gold holdings are significantly higher than annual demand—if they were to sell, it could overwhelm the market. This represents a big demand/supply imbalance.
A psychological investment
Another fundamental challenge with gold is that it is so often a psychological investment. Because of its long history and mystique, people’s perceptions of gold and the value they attribute to it also affect its price. The fears, dreams and greed surrounding gold results in speculation–driven by what people think it could be worth. This greatly impacts the financial market.
Questions that arise in discussions about gold often include: if the financial system falls apart, what would we use as a medium of exchange? What becomes valuable if you no longer trust a fiat bill? The one-dollar U.S. bills say “In God We Trust” and that’s somewhat representative—you have to trust that the government is going to back the currency and not manipulate it. And to be fair, governments have a history of manipulating currency even when they used gold coins. Professor Joseph R. Peden, in his lecture “Inflation and the Fall of the Roman Empire,” outlined how, during the 3rd century of the Roman Empire, the corrupt son of Emperor Septimius Severus, Caracalla, inflated (debased) gold coinage from 45 coins to 50 coins to a pound of gold, and within 20 years it was circulating at 72 coins to a pound of gold. Later in history came coin clipping—where people would shave gold from the edges of coins and turn these clippings into more coins. Currencies got diluted over time and governments started making them with less gold and less silver in order to finance. In his book, “The Origin of Financial Crises”, George Cooper writes:
While coin clipping was practiced within the private sector, in the state sector monetary debasement took on an industrial scale. Governments, especially when in financial trouble, would recall their coinage, melt it down and reform the metal into more coins with a lower gold content. Private sector coin clipping was a crime punishable by death; public sector coin clipping (recoinage) was considered monetary policy; both caused an increase in the number of coins relative to goods and therefore inflation.
So there has always been that lack of fiscal restraint and that carries on to this day, just in different forms.
It may be fair to say that gold is better at preserving wealth than creating it. Say you’re a pirate and you bury your gold. If you dig it up fifty years later, all you’ve got is what you put into the ground. Sure, it didn’t rust and, unless someone found your treasure map, you’ll get the same amount back safe and sound. It might protect wealth over a number of years if the government comes along and ruins fiat money either because of inflation or because they’re pumping too much money into the system. More than anything, though, holding gold as an investment is essentially a form of insurance against a period of hyperinflation or a disastrous event affecting the global financial system. But unless you’re Blackbeard with a chest of gold buried in your backyard, you have to pay a bank to store your gold while it sits doing nothing, so that insurance comes with a price.
Yes, you own that real asset but, for all of that time underground, all you’ll ever have to show for it is that same asset you had in the beginning. It didn’t compound or create revenue for you as an investment. Whereas if you bury a stock certificate that you’ve bought at a reasonable price and dig it up fifty years later you’d have the value of the stock plus any dividends it may have earned over those fifty years, creating a compounding effect—one of the secrets to investing wisely.
It’s about creating wealth not just preserving it
One of the core premises in finance is to create wealth on a real basis by maintaining some kind of discount rate which takes into account the time value of money and also the level of risk associated with the investment. At Mawer, we focus on investing in companies whose discounted future value is greater than their current value. This is ultimately what creates wealth. In our view, it just doesn’t make sense to hold gold as a long-term investment strategy as it is pure speculation. Instead, we construct portfolios of well-run companies that can create wealth over time. Like PC Jeweller—a jewelry retailer headquartered in India that is held in our Global Small Cap Fund. PC Jeweller sells gold, diamonds and jewelry and then reinvests those profits, pays out dividends and grows its business, which provides the compounding effect we’re looking for. They have close to a 20% return on equity and they take that capital and reinvest in new locations where they can sell more product. This resonates particularly well in India, where gold thrives as both a cultural commodity and a status of wealth. Gold there has great religious significance and gold jewelry is given as gifts during weddings, festivals and other special occasions. And the demand for gold jewelry rises because of speculation, which in turn increases their sales. So gold is essentially a tax on Indian celebrations and in some ways a tax on vanity. But that’s all based on a real human desire and demand.
The key is to find different ways to benefit from a theme. One of the most famous examples of this approach occurred during the California gold rush, when the safe play was not trying to pan for gold, it was investing in Levi Strauss, who was selling jeans to all the people who were going to pan for gold. It was an investment in the real infrastructure—and that’s what we are trying to do. Because then it doesn’t matter which way the world economy goes, you’re able to levy a tax on the direction of that trend.
The purest form of investing is when your success boils down simply to a function of time. The opposite strategy is to choose an investment route where the outcome really has no correlation to time. We call that speculation or random luck–where you’re simply rolling the dice. Maybe it works, maybe it doesn’t, but you have no idea. The ultimate test is determining the investments that will be worth more over a very long period of time, just sitting there. We simply don’t see that happening with gold.
It seems people are most interested in making money quickly or protecting their money against their greatest fears. But just because we have the emotions of fear and greed doesn’t mean that we should act on them. Doing so wouldn’t be a very logical conclusion. The trouble we have with providing an opinion on gold is that we just don’t know where the price will go. How could anyone? There’s not a logical basis for understanding gold’s price movement. You are trying to outguess the psychology of the masses. It becomes very complex very quickly.
Shortly after Brexit the price of gold increased. If gold companies increased in value for fear of the EU coming apart and the implications for banks and the financial system, that’s all fear-driven speculation. A much better strategy is to find investments where, if you just leave the world as it is, over time you win. That’s what we try to do with every company we invest in–if their business plan plays out, they collect the earnings on a good service that is going to be around for a very long period of time and those are reinvested at a high rate. Eventually those companies are going to create wealth—not by speculation, just by the function of time.
One last macro thought on that shiny yellow metal—it’s just not a productive asset. It doesn’t contribute in any meaningful way to human advancement in the ways other assets or commodities do. Microsoft, Oracle, Apple, Google—these successful companies grew in value by creating something people wanted which, in our opinion, also made the world better. We think this is a much more viable and valuable long term investment framework, not only as investors but also for society. Think about it this way–imagine if no one invested in productivity, equipment, people and ideas. What if, instead, everyone tried to buy only gold? There would effectively be no society. There would be no activity, no infrastructure, no innovation, just miners and pirates looking for Levis jeans and dreaming of smartphones and Uber.
Paul Moroz is the Deputy Chief Investment Officer and a Director at Mawer Investment Management Ltd., which he joined in 2004. He is the lead manager of the Mawer Global Small Cap Fund and the Mawer Global Equity Fund. As Deputy Chief Investment Officer, he has broad responsibility for the research and analysis of global equities and fixed income securities. In December of 2013, Mr. Moroz won the prestigious Morningstar Foreign Equity Fund Manager of the Year award at the 19th annual Morningstar Awards.
Mr. Moroz relocated to Singapore in 2016 and is currently the CEO and a Director of Mawer Investment Management Singapore Pte. Ltd.