With the gold price dropping around 27% in 2013, many analysts predict that the good times for gold are now over. I am not convinced. Falls of 30-40% are common in long term bull markets and are often just corrections in the overall upward trend.Now we are in 2014 and the metal has already shown some signs that it has bottomed, the only question is: Should I buy gold now?

Historical returns

Before I look at the charts it’s worth bearing in mind the qualities that make gold a viable investment. Ultimately, gold is an excellent store of value. That means it will usually benefit during periods of panic or crisis. It’s also the perfect protector against inflation.

Some commentators seem to believe that gold has no inherent value, that it is a risky commodity and investing in gold is akin to gambling. I disagree, and to prove this point I decided to run some tests and see what the actual historical returns for gold really are.

Buy and hold

I gathered historical gold price data from the World Gold Council starting from 1970 to the present time and tested a simple buy and hold strategy. As you will see from the table, buying gold at market prices (in US dollars) delivered a compounded annual return of 8.38% between December 1970 and December 2014 on an initial capital investment of $10,000. By the end of the period, a $10,000 initial investment would have been worth $344,005.

And that is despite gold doing very little for 20 years between 1980 and 2000. This return is shown in columns 1 and 2.

Table of gold returns

Gold returns

Source: Amibroker

Dollar cost averaging

Another way of investing is to use dollar cost averaging. Simply, this states that you invest a certain amount of money into an asset at regular periods. By doing so, you can capture more shares of something when it is cheap and less shares when it is expensive. This helps to smooth out returns and completely eliminates the need for sharp timing.

To test this strategy, I loaded the historical gold data into the Amibroker trading platfrom and ran a simple DCA system. The system is set up to buy $1000 worth of gold each month. As you can see from the table below, investing in this way would have returned an annual compounded return of 3.99% between 1970 and 2014. The return is not so good. However the same strategy on the S&P would have produced gains almost as good as buy and hold.

Clearly, the results from the buy and hold strategy are better than for DCA. However, for investors without the luxury of having a large initial sum, DCA still allows investors to capture fairly reasonable gains.

Should I buy gold now?

Now that we have confirmed gold as a viable investment option, the only question is whether or not to buy it right now.

My opinion is quite simple; the recent drop in gold represents an excellent opportunity to buy a long term position in the metal, particularly with the unprecedented levels of money printing we have seen in recent years from central banks.

Gold may not necessarily make huge gains this year (inflation is still yet to take off and the US dollar may rise, so gains in gold could be mild in 2014.)

However, when inflation does finally take hold, there will be no holding back for precious metals. Gold is oversold at these levels and is trading lower than it’s 2013 cost of production, which has already caused many gold mines to close and many gold companies to lay off staff.

To conclude, I see gold as a good long term investment at these levels and I would not be surprised to see it hit the $1450 mark some time this year. Should I buy gold now? Yes…

Gold price chart, should I buy gold now?

Source: IG Index

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