It is time for a new investment. As you may have guessed last week: I am buying gold. There are many reasons not to buy gold, and (according to me) many more to buy.
Last week we studied gold history and why it is so popular. We already grasped some of its properties, but let's dig deeper in why it is good to have gold in your portfolio.
The last inflationary spike happened 70s and has been relatively low since then. So why people keep buying gold and why does it just reached a new all-time high?
- Traditionally gold has been viewed as an inflation hedge. However today gold has become an hedge against uncertain markets.
- Gold is uncorrelated to other asset classes such as stocks, bonds and real estate.
- Gold can be used to boost your portfolio performance and reduce its risk.
Gold as an asset
Before 1973 Gold was literally money. There was no gains to be made by owning it. But everything when the United States abandoned the Gold Standard. Now citizens are allowed to privately own (speculate on) gold.
Some argue gold is an asset with various intrinsic qualities that make it unique and necessary for investors to hold in their portfolios.
Other argue gold is a barbaric relic. That it no longer holds the monetary qualities of the past. That gold's only benefit is its use in jewelry and paper is the money of choice.
Moreover gold has a lot of issues as an asset. The biggest? It's a negative carry asset: not only there is no yield on gold, but there are also costs associated with storing it.
The value of gold is an order of magnitude more subjective than even equities because there aren’t any cash flows associated with gold. Gold is a purely speculative asset. Gold has value because, for whatever reason, human beings have arrived at the collective consensus that it’s a store of value over tens of thousands of years.
Gold as an hedge against inflation
In the world of economics and investing, some concepts have become dogma. One such article of faith is that increasing Central Banks balance sheets (i.e. printing money, like they are doing right now) must lead to inflation.
Traditionally, gold has been viewed as an inflation hedge and has been positively correlated with inflation expectations.
Treasuries do well in deflationary busts. Gold does well in periods of high inflation.
In theory, it would make a lot of sense to allocate to REITs (real estate) in place of gold. In an inflationary environment, the real value of the properties would increase while the real value of any debt on them would decrease.
We have not seen periods of high inflation for decades and I am not sure we will see it anytime soon. So if I am not buying gold to hedge against inflation, why am I buying it?
Because these days gold has also become liable to trade up on deflation fears (as well as inflation fears). The meaning of gold has changed. It has shifted from a pure inflation hedge to an insurance policy against economic chaos. It is now an hedge against policy mistakes by our economic and politic elites.
We see that today, without a high inflationary environment, investors still buy gold in period of uncertainty. Gold is not only an hedge against inflation but also against uncertain markets.
The final (and probably the most valid reason) is that gold is uncorrelated to other asset classes. Indeed, the economic forces that define the price of gold are different from the one that define the price of many other asset classes such as stocks, bonds or real estate. To me this reason is the most important one and it justifies why I will always have a portion of my portfolio allocated in gold. Not matter if we are heading to a new inflation episode or not.
Gold as an uncorrelated asset
Let's look at gold from an investment point of view. Well... it is not that good:
If you invested $1 in gold when it was decoupled from the U.S. dollar in 1973, it would be worth about $2 today. Whereas the same $1 investment in S&P500 would be worth 12 times more ($24).
We find similar results if we look at the past 10 years:
Past performance does not indicative of future results, so we can't use it to predict future performance of gold. However we clearly see that gold can be very profitable for short period of time (2005-2011) and then a large draw-down and almost a decade before reaching its last peak again (2011-2020). So holding gold can be painful. It is even more striking on the risk-return graph (more on that next week):
Holding gold is more risky and less profitable than most assets. Then, why bother investing in gold on the long run? Because it is uncorrelated.
For example, imagine a portfolio with an equal split into three asset classes: the S&P 500 (33.3%), long-term U.S. bonds (33.3%), and emerging market stocks (33.3%). Now take that portfolio and add gold so that the split goes to 25% each, such as: S&P 500 (25%), long-term U.S. bonds (25%), emerging market stocks (25%), and gold (25%).
If you were to compare the growth of these two portfolios, the one with gold would have outperformed:
That is the power of uncorrelated assets.
How to buy Gold?
As we did for high-yield bonds, I will use an exchange-traded fund (ETF) to buy gold. ETFs are relatively cost efficient and secure way to access the gold market. And way more convenient than buying (and storing) physical gold.
I bought shares of one of largest and liquid of them: SPDR Gold Shares.
Do you agree with this investment? If not, what would you buy instead?
That’s all for today!
If you enjoyed the article retweeting the thread on Twitter is appreciated :)
Also, if you have any question or feedback: feel free to leave a comment :)
See you next week!
Kevin from Hook
Further readings and useful links:
- Why is Gold so popular?
- Making good decisions in uncertain times
- Road to inflation and real-time inflation measurement during COVID-19
- Join eToro using my affiliate link and find my portfolio under @kprimice
This newsletter does not provide investment advice
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