The price of gold has jumped almost 30% in a little over six months, and the investment community is getting excited about the yellow metal again. Personally, I'll be sitting this gold rally out and sticking with my high quality dividend stock investment strategy. Here are five reasons why.
Dividends are the real winners
The main issue I have with gold as an investment is that it doesn't produce any income. And I'm certainly not the only one who thinks along these lines, with Warren Buffett classifying gold as a 'non-productive asset' and making his aversion to the metal very clear.
Many studies show that over the long term, dividends can actually contribute up to 90% of total investment returns. It's the power of compounding these dividends over a long period of time that really generates big wealth. If you compare the performance of gold to the S&P 500 index over the last 20 years to the end of July, gold actually comes out in front with a return of 245% vs 240%. However, once you factor-in dividend reinvestment, the index return jumps to 393% - a significant difference in favour of equities. And this is the problem with gold - with no dividends there's no compounding, so if you buy one bar of bullion today, you'll still have one bar of bullion in a decade.
The fact that gold produces no cash flows leads to another problem - it's hard to value. Ask equity analysts how they value a stock and they'll likely discuss discounted cash flow models in which a business's future cash flows are discounted for risk, and a valuation is generated. With gold producing no cash flows, how can it be valued accurately?
Without the ability to accurately value gold, you're relying on one thing to be able to sell your gold for a profit - fear. Warren Buffett explains: "Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn't produce anything."
Many investors buy gold as an inflation hedge. And with governments around the world pumping endless amounts of quantitative easing money into their economies, I can understand why investors would be looking for protection.
However I'm not convinced gold is a reliable hedge, due to its large fluctuations in price.
For example, if you'd bought gold in 1980 for US $750, 20 years later it would only have been worth $260. Similarly if you had bought in 2012 for US $1,800 and wanted to sell earlier this year, you would have been looking at a 40% loss.
Lastly, whereas stocks pay dividends, gold will actually cost you money. Unless you bury your gold in your garden, it's likely you'll need to pay for insurance and storage costs and these fees add up.
So when it comes to dividend-paying stocks vs gold, the stocks win every time to my mind. I'll be sticking with my dividend reinvestment strategy and leaving the gold to the gold bugs.