Volatility of gold vs. shares

These posts were moved from this thread Brendan Burgess explains how to protect your deposits
I have reedited the thread to emphasise the key point that all alternatives to deposits in euro carry risk - Brendan

IMPORTANT

The following quotes are taken directly from the above key post. It is important to stess that empirical evidence suggests that the following statements made are factually inaccurate:


"What about buying shares directly?
Buying shares directly is a good way to get exposure to foreign currencies. Most blue chip Irish companies such as CRH, DCC, and Aryzta have earnings in a combination of euro, dollars and sterling. ( Note: the author owns shares in these companies)"

"What about gold and other precious metals?
These are very risky."

Analysis of CRH compared to the spot price of gold over the period Jan 1999 to June 2010 in Euros
Source: Bloomberg for all following analysis.

Average annual return
Gold 13.55%pa
CRH 3.05%pa

Average volatilty as measured by Standard Deviation

Gold 16.79
CRH 29.61

Since 1999 CRH has been more risky than gold yet the post claims that an investment in precious metals is "very risky" and suggests investing in CRH is a "Blue Chip investment".

Out of sample tests:

To set aside any claims of data mining I have tested the volatility of gold in Irish Pounds since 1986 to October 2010

The average annual return was 6.49%pa
Average annual volatility 15.38%

Testing in US Dollars over the period Jan 1970 to October 2010

Average annual return 12.03%pa
Average annual volatility 26.24

Over all these periods the average annual volatility of the spot price of gold has been LOWER than an investment in a single company like CRH suggesting that an investment in gold over the last 40 years has been less risky than an investment in any randomly selected single company (especially if that company was Anglo Irish Bank. Northern Rock, Bradford & Bingley, AIB, Bank of Ireland, Enron, Worldcom, British Telecom, Marconi, Energis, etc etc etc).

For additional reference the following selection of shares had the following characteristics:

All data in Irish Pounds/Euros over the period Dec 1990 Dec 2008

Stock Average annual volatility
Wal Mart 26.39
Intel 43.19
Bank of Ireland 33.01
Tesco 24.14
Aviva 28.48
Vodaphone 30.86
AIB 33.12
Pfizer 25.31
Gold 14.94

Secondly "the best way to protect against inflation is to hold real assets such as property or shares."

Let's consider the period December 1961 to January 1975 in US Dollars.
US Consumer price inflation averaged 4.28%pa
S&P 500 average 3.97%pa

Shares can be a poor "hedge" against inflation over extremely long periods and there is no guarantee that real assets such as equities or property WILL be a good hedge against rising prices. Equally commodities can be a poor hedge against inflation contrary to popular opinion.

The reason for this is that the variation in equity, property and commodity prices relative to the volatility of inflation means that the volatility of real assets swamps the variation from month to month of inflation.

The annual standard deviation of inflation over the period above was just 1.06% whereas the volatility of the S&P 500 was 14.58%.

If investors are looking for a reliable hedge against inflation they need something that has a low volatility options such as T Bills or Treasury Notes are more reliable hedges against inflation.

Volatility of One month T Bills over this period was 0.47% and the average annual return was 4.89%pa ( a positive return above inflation).

5 Year Treasure Notes average an annual return of 4.74%pa with a volatility of 4.05%. Again a positive real return with low volatility.

Therefore investors seeking to offset inflation risk are better off using short-term fixed interest rather than real assets if they want a more reliable hedge.

Out of sample test to confirm these assertions:

Period Jan 1926 to October 2010 in US Dollars

US Consumer price index average 3%pa
US One Month T Bills 3.62%pa
5 Year Treasury Notes 5.39%pa

Conclusion: Short term fixed interest is a reliable hedge against inflation whereas real assets are a less reliable hedge.

Hi Marc


I have pointed out very clearly that there is no risk-free investment. It is very clear that investing in shares is risky.

Unfortunately, a lot of people believe that gold is not a risky investment.

I am simply pointing out that it is a risky investment and not the safe haven that it is promoted as.

Analysis of CRH compared to the spot price of gold over the period Jan 1999 to June 2010 in Euros
Source: Bloomberg for all following analysis.

Average annual return
Gold 13.55%pa
CRH 3.05%pa

Click to expand...

Marc - why have you chosen those particular dates? You give volatility going back to 1970. Perhaps you would give the figures for the return on both since 1970?

I presume that you are not involved in the selling of gold? If, by any chance you are, you should disclose your interest.

Brendan,

My concern is that your use of the phrase "blue chip" when referring to an investment in a single company is just as egregious as referring to gold as a "safe haven". Private investors should not be encouraged to speculate on the fortunes of an single company since the downside risk (i.e the risk of a total loss of all capital) is too great for a typical investor to bear - especially when they can hold a diversified index fund and avoid stock specific risk altogether.

I would agree with you that the use of certain terminology can lead investors to make poor investment decisions - "new paradigm" when talking about tech stocks for example. But I would also argue that your use of the word "bubble" is also misleading. You only know after the fact if the price you pay today is too high. The efficient market hypothesis states that the price of all publicly traded securities including gold incorporate the views and opions of ALL market participants. For every buyer there has to be a seller and for every long there is a short. To state that the current price is wrong (i.e. in a bubble) implies that one has more knowledge about the "correct" price than ALL market participants - everyone else is wrong and I am right.

A more rationale position to take is that the market does a fairly good job of pricing risk and expected returns. Supply and demand matches buyers and sellers and the current price can therefore be considered to be "fair".

That said, I am perfectly willing to concede that an investment in gold carries risk but the inference in your original post was that it is "very risky" whereas an investment in CRH was a "blue chip" investment. In so doing, you were presenting a misleading picture of the relative risks.

I have shown statistically that this is not the case. The volatility of the spot price of gold is on average lower than that of a random selection of stocks.

The dates selected for the CRH gold comparison were simply from the start of the euro to the latest date I had for CRH data.

The additional analysis was to set aside any charges of data mining.

However, to set aside any concerns you might have, I have obtained the monthly return on CRH ADRs in US$ compared to the spot price of gold over the period Jan 1995 to Oct 2010. If I can obtain data for CRH over a longer time period in the morning I will do so.

The results for the 1995 to 2010 series are as follows:

Gold average annual return 8.86%pa volatility 21.72%
CRH average annual return 9.98%pa volatility 28.97%

Again supporting the notion that an investment in CRH or indeed any stock selected at random is consistently more risky than an investment in gold.

Finally, by way of disclosure I am not directly or personally involved in the selling of gold although I do work in a company that offers precious metals investments. This is like asking a stockbroker to disclose if they also arrange foreign exchange transactions or open bank accounts for their clients.

That said, I do generally recommend that all investors should hold a modest allocation to gold as part of a diversified portfolio of assets and this recommendation is based on sound empirical studies of risk and return rather than the blind speculation and crystal ball gazing so popular with many advisers and fund managers.

That said, I am perfectly willing to concede that an investment in gold carries risk but the inference in your original post was that it is "very risky" whereas an investment in CRH was a "blue chip" investment. In so doing, you were presenting a misleading picture of the relative risks.

Click to expand...

There was no intended suggestion that anyone should invest in one particular share, no matter how blue chip. I mentioned a few shares. I would not have thought that there was a need to clarify that one should have a portfolio of shares, but just in case, I will revise that wording.

Again I would stress that a lot of people think that gold is not risky. Gold, especially at its current price, is very risky. That does not mean that it will fall in price. It just means that there is a significant risk of a significant fall.

I've finally managed to get the Bloomberg terminal working to look into the data for Gold vs CRH.

The longest data series I can obtain for CRH is back to Feb 1987 in Irish Punts/Euros to end November 2010.

So, to test my hypothesis that investing in gold is less risky than an investment in a single "bluechip" stock such as CRH, I ran some more numbers.

Between Feb 1987 and Nov 2010

The worst one year return for CRH was -49.77%
Whereas the worst one year return for gold was -25.32%

The lowest three year annualized returns:
CRH -24.72%
Gold -13.96%

Looking at individual months

CRH worst month August 2010 -23.43%
Gold worst month Oct 2008 -16.89%

As I have already pointed out the current price does not impact on the relative risk of an investment made today. The reason for this is that the best guess of a fair price of any publicly traded security is it's current price. We only know after the fact, once new information comes to light if the guess made by the market was too high or too low.

Whereas if you invest in any single stock in addition to the market risk you are also exposed to the ideosyncratic risks of that particular company. The good and bad luck that happens and the good and bad management decisions. Investors can (and should) diversify away risks like these that they are not being paid to take. Stock specific risk can be reduced by holding more stocks and therefore investors should not be encouraged to speculate on the fortunes of any single company when they can diversify stock specific risk by holding an index.

Whilst this might (under certain circumstances) be less tax efficient this is a classic case of not letting the "tax tail wag the investment dog".

So, what if your investment is slightly less tax efficient. If you are more diverisified you are less exposed to the very real risk of a company going bust and taking out your investment.

Investors can hold low cost, globally diversified index funds. They do not need to speculate on the fortunes or otherwise of a narrow range of Irish companies.

Furthermore, it is my contention (and the evidence seems to support this) that the risk of loss is probably greater when buying single stocks than when making an investment in gold bullion and we can backtest this by picking stocks at random and comparing the statistics against the spot price of gold over various periods.

Yet, Irish investors have previously been advised that they should buy individual stocks rather than funds due to the apparent capital gains tax benefits (http://www.askaboutmoney.com/showthread.php?t=6805).

Modern portfolio theory would say that this is very risky and investors would be better off not doing this and should hold an index fund instead despite any possible tax differences. After all, if you lose all your money in Anglo Irish shares who cares if it is tax free?