Gold is typically hailed as something of a safehaven amongst investors, utilised when fear and volatility are both riding high. It also tends to benefit during periods of low interest rates, when the opportunity cost is lower for investors (that is, they aren't able to earn high risk-free returns so holding gold becomes more appealing).
Indeed, the gold miners themselves enjoyed astounding returns during 2016, while many also started 2017 with a bang. St Barbara Ltd (ASX: SBM), for instance, is sporting a return of 20% over the past 12 months while Newcrest Mining Limited (ASX: NCM) and Northern Star Resources Ltd (ASX: NST) have gained 37% and 20%, respectively. Evolution Mining Ltd (ASX: EVN) is up an impressive 42% during that time, as well.
As appealing as those returns may seem, however, investors should note that it hasn't all been smooth sailing. One look at the chart below shows how volatile the S&P/ASX All Ords Gold (Index: ^AXGD) (ASX: XGD) index has been during that time, despite its clear outperformance compared to the broader S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).
The volatility becomes even more evident the further out we look. The next chart contrasts the Gold index with the ASX 200 over a 10-year period. Coincidentally, it shows the two indices have returned the same during that time (although both exclude any returns generated through dividends), but it has been a much smoother ride for investors outside the gold sector.
It is inherently difficult to predict the price of gold, partly due to the fact there are many moving parts that can influence its value. For starters, fear and volatility tend to drive the price higher – at least for a short while – while low interest rates and a weak U.S. dollar can also drive the price higher.
Although the gold price has risen recently (which has positively influenced the returns generated by the gold miners) there are reasons to doubt whether that will continue. Indeed, interest rates in the United States are expected to continue rising this year while President Trump's proposed tax cuts could also strengthen the U.S. currency. Both of those factors would likely weigh on the price of gold, and thus the gold miners themselves.
The volatile nature of the gold sector can lead to outsized returns for investors with exposure when the gold price is rising. But as you can see in each of the charts above, investors who are exposed to the sector when the going gets tough can experience very sharp losses. As such, it is my opinion that long-term investors are better off focusing on high-quality businesses that are not reliant on a buoyant gold price to generate strong returns for their shareholders.
