Losing its Lustre (Hyndman)

Losing its Lustre

by Jamie Hyndman, Mawer Investment Management

April 18, 2013

It’s been an ugly few weeks for gold investors. Gold peaked at approximately $1,900 USD an ounce in September 2011, but has since fallen to the $1,350 range this week.

The trigger could be that Cyprus is selling part of its gold holdings to help fund its bailout. It could just be that some influential investment firms, like Goldman Sachs, have put out negative opinion pieces on the shiny yellow metal. Or, it may indicate that investors are starting to believe that central banks are going to be able to navigate through their sovereign debt issues and also revive global economies without inciting rampant price inflation.

But in truth, we don’t actually know why gold is down. Nor did we know why it went up. Gold is probably down because…gold is down. And it probably went up because…it was going up. Suffice to say that we don’t spend much time following gold markets. And here’s why: while gold has performed well over the last decade or so, over the very long-term, gold has been an abysmal thing to invest in. The primary reason for this is that the magic of compounding is absent in a hard asset such as gold. And make no mistake, the function of compounding is the quintessential mathematical concept for investors to understand. Compounding grows wealth in an exponential path, rather than in a linear one. And not only does gold not pay you a coupon or dividend, but it has a cost of carry – you have to pay someone to store it safely for you!

Another reason to take a pass on gold, or any other hard asset for that matter, is that it can’t think. I know that sounds ridiculous, but let’s compare gold with a great company, such as GE or IBM. A company has human capital – the entrepreneurial spirit, the work ethic, and the intellectual capacity to develop products and services that consumers want and to constantly re-invent itself as times change – all the time growing its earnings. Gold just sits there, looking pretty but remaining idle. If gold were smart, it would make itself easier to mine, lighten itself up a bit so it’s easier to transport, develop some new properties, find some new markets to sell itself in, and perhaps launch a smear campaign against platinum, which has really been gaining market share on it lately!

So without the benefit of financial compounding, nor the backing of human ingenuity, gold appears to us as nothing more than a second tier industrial metal. To invest in it at what we think are still lofty levels strikes us more as speculation than investing. We know it’s widely followed by investors around the world, and fully expect it to bounce back someday. However, rather than getting distracted by shiny objects, we’re happy to watch this story from afar and instead focus on investing in companies that we believe will better compound wealth over time.

Jamie Hyndman

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