Gold investment advantages and disadvantages
This week we take a look at the advantages and disadvantages of gold investment.
Right now the world is on the brink of collapse. Europe is on it’s knees as Germany goes into recession, Italy get’s in even more debt and the UK prepares to jump the sinking ship via Brexit for better or worse.
Across the pond the US is in the midst of a trade war with China and that’s just one of China’s 99 problems. Slowing growth, demonstrations in Hong Kong and debt problems not dissimilar from the Italians to name but a few.
When the world looks scary investors tend to move out of stocks and put their money into nice safe high quality government bonds.
But with US 10 years currently yielding just 1.6%, UK 10 years yielding a pathetic 0.5% and most of the rest of the developed world yielding negatively, it’s no surprise that people are turning to alternatives.
Of course millenials have got it covered with Bitcoin, but for the rest of us gold seems like a safer option.
After all, every one knows gold is a safe haven, somewhere to put your money when the world is heading for trouble.
We’ll be looking at both sides of the coin, but let’s start with the advantages of gold.
Gold is a real asset
Unlike stocks and bonds that amount to nothing more than pieces of paper for most investors, gold is a real asset like real estate that you can touch.
In fact, unlike real estate, and providing you don’t have too much of it, you can take gold with you when you move around.
There are plenty of stories of how people all over the world were able to escape wars and set up new lives using gold they carried on their person.
An inflation hedge
Gold is famed for being an inflation hedge. As bigger reason as any for this, was it’s inclusion in Harry Browne’s Permanent Portfolio.
There’s a never ending line of model portfolio’s out there but non have as much of a cult following as Mr Browne’s.
Harry was an American writer, politician and investment advisor. In his book Fail Safe Investing he detailed a portfolio that would do well in the good times, but more importantly, and where it differed from alternatives, was that it was designed to do well in the bad times too.
It works by diversifying equally across stocks, bonds, gold and cash which have a tendency to move in opposite directions with one another.
Whenever one of the four assets takes a dive, at least one of the other three will go up to counteract any negative impact.
The Permanent Portfolio is based on four economic conditions: Prosperity, Deflation, Recession, and Inflation.
According to Harry this final condition is where gold comes in because gold is great for protecting against inflation.
Gold is a safe haven
Bridgewater Associates is the biggest hedge fund in the world. It’s founder Ray Dalio is a big proponent of gold.
He argues that gold diversifies against other assets, political uncertainly and all the dollar denominated debt in the world.
As a result he thinks all investors should have between 5 and 10 percent of their portfolio allocated to gold.
One of the most popular investing books out there Money Master the Game by Tony Robins sets out Ray Dalio’s All Weather Portfolio. Following this model portfolio investors would have 7.5% of their investments in gold.
Dalio is pretty famous in the in the investing world, but there is nobody more famous than Warren Buffett, and almost as well known is the fact that Buffett isn’t a fan of gold. He’s often on TV explaining why he doesn’t invest in it.
But even he seems to think the idea of gold is a safe haven has some merit.
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.
Warren Buffet
The price of gold will go up
In Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment by David Swensen, the Chief Investment Officer at Yale University, the returns on different US investments over a 200 year period from December 1802 until December 2005 are given.
The value of gold increased 27 times over that period.
In more recent times gold has performed a little better than many people appreciate.
The table below shows compares the returns of gold and global stocks since 1998.
Investment returns for gold and global stocks since 1998
During the time period global stocks had a compound annual growth rate of 5% compared to 12% for gold.
If you’d invested $10,000 in gold in 1998 you’d have over $55,000 today, compared to just $21,000 you’d have had by investing in global stocks.
In other words, gold investment has blown stocks out of the water!
Let’s take a look at some major disadvantages of gold.
Storage
Unless you have a couple of security cameras, a couple of guard dogs and a safe, you are probably going to need to pay for storage.
Even if you invest in paper gold via something like an Exchange Traded Fund, the cost of gold storage will be hidden in your ongoing charges somewhere.
It doesn’t go up as much as other assets
Yes, gold has increased in value over time, and yes it’s performed great since 1998, but I chose that time for a reason. The time period contains two big stock market crashes in 2000 and 2008. Times when gold does well.
There’s nothing better than gold to put the brakes on your investment portfolio when stocks are racing ahead on a bull run.
If you’d started investing after the 2008 crash things would’ve turned out a little different. The table below shows the returns of gold and stocks over the last decade.
Investment returns for gold and global stocks since 2010
During that time period global stocks had a compound annual growth rate of 8.7% vs just 2.3% for gold. Investing in stocks would have turned $10,000 into about $22,200 dollars, whereas you’d have been left with just about $12,400 by investing in the yellow metal.
In other words stocks have trounced gold over the last decade!
In fact, it turns out that more often than not stocks beat gold.
That 200 year period in Swensen’s Pioneering Portfolio Management doesn’t just contain gold. The number of times bonds and stocks have multiplied in value is also given, and when gold is compared to the other two, it doesn’t look quite as good an investment.
Gold –> 27
Treasury bonds –> 19,500
Stocks –> 10,300,000
Gold isn’t a real asset for most investors
Most people who invest in gold don’t buy real gold. Instead, they invest in things like exchange traded funds (ETFs), and though some of those ETFs are actually backed by the physical stuff, they are essentially pieces of paper just like you get when you invest in stocks and bonds.
It isn’t a true safe haven
And it follows that gold is probably not quite as much of a safe haven as people think. If the world really did go to hell, paper gold probably wouldn’t do you much good.
Even the physical stuff might not be quite the savior you are looking for. Tinned food and guns might stand you in better stead.
It isn’t the inflation hedge everybody thinks it is
Benjamin Graham, Warren Buffett’s teacher often called the father of value investing in his investing classic the Intelligent Investor writes:
The near-complete failure of gold to protect against a loss in the purchasing power of the dollar must cast grave doubt on the ability of the ordinary investor to protect himself against inflation by putting his money in “things.”
Benjamin Graham
A compromise.
A less extreme view is shared by two well known names. Investing guru, Bill Bernstein and Yale CIO, David Swensen both provide a strong argument for investing in commodity companies like gold miners rather than actual commodities like gold itself.
In his superb book, Deep Risk, investing guru Bill Bernstein says commodity producers are more effective at inflation protection than commodities themselves.
His thoughts are echoed by Swensen in Pioneering Portfolio Management, where he says:
Pure commodity price exposure holds little interest to sensible investors, as long-term returns approximately equal inflation rates.
Unlike commodity indices, which give investors simple price exposure, well-chosen and well-structured real assets investments provide price exposure plus an intrinsic rate of return.
David Swensen
In other words investing in gold companies might be a better idea than investing in gold itself.
And its worth pointing out, that anybody who invests in a global index fund is more than likely going to have a fair few gold companies in their portfolio.
In the Vanguard FTSE All-World UCITS ETF for example 4 of the top 5 gold companies in the world are included.
The bottom line
Gold divides people rather like Marmite. They either love it or hate it. Some model investment portfolios like those from the likes of Dalio and Browne are packed with the stuff, others less so.
In fact, I’m pretty sure most model portfolios don’t contain gold.
But that’s gold as a commodity or the metal itself, it wouldn’t surprise me if just about all model portfolio’s contain exposure to gold through companies.
Because most of the major indices out there contain a few gold companies and just about anybody who invests in an index fund, particularly a global index is likely to have exposure through gold companies, rather than the actual metal itself.
In a way, investing in the companies themselves satisfies a lot of the reasons to hold gold in a portfolio, whilst at the same time pacifying those that are anti gold like Buffett. Buffett likes companies and gold companies are well…….companies!
But if you really want to invest in the gold itself rather than gold companies 5% seems like a good number.
That’s enough for a gold bug like Ray Dalio, but it also seems to be acceptable for the anti-gold establishment.
The late Jack Bogle, founder of Vanguard and creator of the first index fund wasn’t a fan of gold, but even he has been known to soften on occasion:
Gold is the best diversifier of all. In the short run, it can help you if there is rampant or hyper-inflation. In the long run, it’s a loser’s game. It has no internal rate of return. Bonds have interest rates. Stocks have a dividend yield or earnings growth. Gold has nothing like that. It’s complete speculation. If you are enamoured with gold, 5% of your portfolio is okay.
Jack Bogle
