In my column of April 30 I mentioned the recent weakness in the local stock market. Gold shares have fared worse than most other shares and have been poor performers for over two years now.
Out-of-favour sectors always interest me and warrant a closer look - no pun intended: investing directly in gold shares is hair-raising enough.
Over the past decade, the gold sector of the JSE Securities Exchange beat the rest of the market in only three of those years (measured over the calendar year). In 2001 and 2002, gold shares staged dramatic moves, with counters such as Gold Fields gaining over 300 percent.
However, in two years during the past decade the gold sector under-performed the market by more than 50 percent a year. Investors in Gold Fields, for example, saw their shares drop by 70 percent in three years in the late nineties.
Gold is not a sector for the faint-hearted and is most definitely not for the emotional investor. Yet there is a subset of investors who get a glazed look in their eyes when you mention gold shares. I am never sure if that glazed look is caused by their eyes misting over as they mourn past losses, or nostalgia at past successes, or wistfulness over lost opportunities in the gold sector.
Perennial gold bulls also tend to have interesting conspiracy theories, but let's not gild all gold investors with the same brush.
Sobering facts
It is useful to list some of the myths surrounding gold shares and then to face the sobering facts before considering investing in this sector.
- Myth: There is a lot of money to be made in gold shares. Reality: In the past decade, gold shares lagged the rest of the market in most years.
- Myth: Investing in gold shares is a good hedge against rand weakness. Reality: The rand itself has little influence on the behaviour of gold shares. It is the combination of the rand-United States dollar exchange rate and the US dollar price of gold that affects gold shares.
History lessons
What truths can history teach us about gold shares?
A rather simplistic but helpful way of answering this question is to examine how various factors have influenced South African gold shares and the gold price itself. Looking at history in an attempt to predict the future is certainly flawed, but it serves an important purpose in shattering preconceived ideas.
A look at the factors influencing the monthly move in Gold Fields' share price yields an interesting result. I have used Gold Fields as an indicator of how gold shares in general behave, because it currently comprises 40 percent of the gold index, which indicates the aggregate performance of gold shares on the JSE. Where data has allowed, I have taken the analysis back to the 1960s.
The factors, from most important to least important, are:
- The performance of the stock market (the JSE as measured by the All Share Index). This may come as a bit of a surprise, given gold's reputation as a doomsday investment. Bear in mind, however, that the relationship between investment variables changes over time.
The relationship between the performance of the gold sector and that of the overall market was strongest until the late 1990s, but during the past few years, the relationship is no longer obvious. This might be a result of persistent rand strength, which has continued to fuel the local market but hurt gold shares, especially when combined with a weaker gold price. In the second half of the last century, gold mining was more important to the South African economy and the performance of the JSE, so it followed that the market did well when gold shares did well.
- The gold price in rands.
- The gold price in US dollars.
The rand-US dollar exchange rate on its own, however, hardly has any influence at all. So it would appear on first impressions that the only sound reason to invest in gold shares is because you are positive on the overall market, the rand, or the US dollar gold price, or all three. Buying gold only because you think the rand is going to weaken does not seem to make sense.
US dollar gold price
What factors influence the US dollar price of gold?
- US dollar weakness is the most potent influence. This makes sense because gold is viewed as an alternative to the most powerful currency in the world if that currency is perceived to be weak.
- Inflation, which also makes sense because gold is supposed to retain its value when inflation erodes the value of other assets and currencies.
- The oil price. This is also logical, because persistently higher oil prices affect inflation. Recently, however, higher oil prices have not had a positive effect on the gold price.
Reasons to buy gold
Why (and when) would you want to own gold shares?
- If you believe the rand gold price is going to rise, perhaps because you think major world currencies are troubled (especially the US dollar).
- If you are bearish on the US dollar and, as a result, the US market. In this case, buying gold shares may give your portfolio some valuable diversification, because you could argue that US investors might buy gold and gold shares as a safer haven when they are worried about their currency and market.
However, raising your investment in South African cash might have a similar effect and also provide some stability to your overall portfolio, because the rand could remain steady when the US dollar is weak. Sure, having cash is not going to make you those quick gains, but it is less likely to lose you money if you are looking for protection from US market declines.
- If you are prepared to sell your gold shares after you have made your profits, because gold shares tend not to be long-term investments. Good trading profits can be made by buying gold shares, especially when gold shares have been weak and out of favour for a long time.
It is likely that people lie more about their "success" in the gold market than about their weight, age, salary or returns on property. Gold is a tricky sector, and if you are not prepared to accept the risks of investing in gold shares, rather look at alternatives to guard against market falls, such as increasing the cash component of your portfolio.
Large gains can be made in gold shares during times of uncertainty and turmoil in other investments. But there is no guarantee that gold shares will always rise in these times.