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In: Finance

Financial market commentators often argue that it is unwise to invest in precious metals, as they...

Financial market commentators often argue that it is unwise to invest in precious metals, as they historically have lower average returns and higher risk compared to equities. In light of this evidence, discuss whether there is any justification for an investor with mean-variance utility preferences to invest in precious metals as opposed to equities.

Solutions

Expert Solution

Let us discuss briefly about investment in stocks and Precious metal first

Investment in Stock/Equity

Those who investing the stock/equity get the ownership in the company issuing stocks. Stock holders receive more money when the company they hold the stock shows better performance, increase in their profit and hence create more demand for their equity. Thus the price of the stock will increase and it will provide more profit to Stock holder

Investment in Precious Metal

Investment in precious metal, the owner of metals holds a Physical product. This Investment is comes under the category of commodity. The main kind of investment in metals are investment in Gold. Investment in Silver etc. where the investor receive more money when the requirement for the particular metal is increased and more demand rises the spot price of the metal

As pointed out in the question, historically the performance of a stock market is far better than of investment in precious metal/commodity. That time the investment in metal considered as more risky and not advised as a profit seeking investment. The investment in stocks give more profit to the investors and risk factor is less comparatively

But during the last 15-20 years, things got changed dramatically. The performance of gold and silver outperformed the investment in equity. The analysis and studies of various stock market indexes like DJIA (Dow Jones industrial average), NASDQ etc. clearly indicate these trends.

What make these changes?

As noted above, historically for more than 60 years, the stocks outperformed the metal. But due to the below changes, the trends are reversed after the year 2000

· High market volatility: Compare to the historical investment years, the stock markets are extremely volatile in the new era. Thus the demand for the metals like gold, silver etc. has been increased as the investors want to reduce their risk and hedge their position

· Changes in Monetary policy of Govt: Major Governments of different countries loose their monetary policies by contribute more cash in to the economy and thereby rise the price of commodities

· Debt Crisis; Major Powers like US, European countries etc. faced excessive debt and leverage level.and has an impact on stock market. Hence investors prefer commodity over risky stock market

· Recession : The great recession occurred during 2007-2009 was hit national economies globally and caused market crashes. So investors started to invest in commodities more than of risky stock market

To be conclude, the traditional method of investment in stock has its own importance. But due to the changes in various economic factors during the last two decades, investment in Precious metals like gold, silver etc. Seems to be more safe and smarter.

Now the world is going through a tough period as Corona Pandemic is ongoing. Hence most of the economy is down and market is volatile. So it is better to prefer investment in commodity than equity (As of present date)


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