Over the next two decades, there’s a decent chance an investment in cheap UK shares now will go on to outperform an investment in gold.
I believe that because the stock market has a reputation for beating the returns from all other major asset classes over the long term.
That means the returns from stocks and shares in general have beaten those from property, commodities, cash savings bonds and other assets.
But gold has given shares some stiff competition over the past 20 years. Since 2003, the price of gold measured against the US dollar has increased by just over 460%. And as I write, a troy ounce of gold is valued at about $1,936.
Inflation protection
Investors tend to view gold as a safe-haven investment in troubled economic times. And many also consider it to be a hedge against inflation.
But the ride for ‘gold bugs’ has been white-knuckle. In 2011, it was above $1,800. But by 2016, it was around $1,000 and on 11 July, it was almost double that figure.
Meanwhile, businesses can also work well to protect investors from the ravages of inflation. Many raise selling prices to overcome the effects of rising costs. And that tends to push up revenues, earnings, cash flows, shareholder dividends and share prices.
However, that’s a broad-brush theory and it doesn’t iron out volatility for stocks and shares. If it did, we wouldn’t be where we are today with many business valuations on the floor because of negative investor sentiment and struggling underlying businesses.
Economic cycles and macroeconomic shocks can cause businesses to suffer and make it hard for many of them to turn a profit. So in many cases, lower valuations and fallen share prices make sense.
And each economic downturn can leave casualties in its wake. Some businesses fall so hard, the impact damages them forever. Investing in stocks and shares comes with risks as well as opportunities.
Conditions will likely improve
But I’d prefer to hunt for the hidden gems when valuations are cheap rather than when the economic outlook is rosy and valuations are expensive. It’s the classic contrarian approach to long-term investing practised by billionaire Warren Buffett and many others.
And I believe that what goes up will also tend to come down – eventually. And that includes inflation, economic uncertainty and the value of gold against the dollar. So for me, that rules out taking a position in gold right now.
However, the theory behind my long-term investments in cheap shares relies on switching that belief around. And to me that means what goes down will likely go up again in the end. That includes investor sentiment, the general economic outlook, the valuations of quality businesses, and their share prices.
So I’m working hard on my watchlist now and buying select shares with some urgency before the next widespread stock market rally arrives.
