S&P 500 Chart: Q1 2014
The next topic is whether gold is a good investment, a question that came up recently in a client discussion. Many asset allocation models call for an allocation to gold, often recommending around 5% of total assets. DIA’s belief is that gold is a poor investment and not worth even a small allocation. Gold has a reputation as a hedge against inflation and a weakening dollar, as well as against a falling stock market and general economic turmoil. The evidence shows that gold does not really provide these benefits and therefore in DIA's view simply acts as "dead weight" in a portfolio.
Gold’s value is purely psychological, not economic. There are industrial uses and jewelry, but these do not create nearly enough demand to support current prices and production. Gold is valuable simply because for thousands of years and in varied cultures it has served as a store of value. But gold offers no income or potential for earnings, unlike stocks, bonds, cash and real estate. Gold ultimately has little intrinsic value, only worth what other people are willing to pay for it.
What about gold as a hedge against inflation and a deteriorating dollar? Gold gained its reputation as an inflation and currency hedge in the 1970s when inflation was high and gold prices rose sharply, peaking at $850 in January 1980 (over $2,400 in today’s dollars, far above today’s price of gold). Since then gold has not tracked inflation but the idea that they are connected persists. In fact, gold declined from 1980-2001 even as the Consumer Price Index more than doubled. A detailed 2013 study titled "The Golden Dilemma" by a Duke University professor and a prominent commodities trader shows that gold’s price has little correlation to inflation, both short and long term. The study also concludes that "the change in the real price of gold seems to be largely independent of the change in currency values."
What about as a stock market hedge or protection against an economic crisis? Again, the results are erratic. For example, 2008 was a year of severe economic turmoil, arguably the worst since the Great Depression with stocks dropping about 40%, a perfect time for gold to supposedly soar – however, gold was up only 1% for the year – cash in the bank would have been a better hedge. If gold did not rise when stocks collapsed, then when will it go up?
Gold prices are apparently based on various random factors that are impossible to assess: interest rates (when rates go up gold supposedly goes down, since the incentive to hold gold is reduced when cash is more attractive), currency values, purchases by people in China and India, gold sales by central banks, fear of an economic crisis, etc. As one trader put it when gold was in an upsurge recently: "gold is going up because people are buying it, and people are buying it because it’s going up."
So called “gold bugs” hold almost a religious conviction that gold is the only protection from a looming financial crisis or worldwide economic crash, which is always just around the corner. If one believes that the world is approaching a financial collapse then a 5% allocation is meaningless. Some of the ads by gold selling firms use fear to sell gold (see page A13 of the April 1st New York Times), claiming that the U.S. dollar is becoming worthless – which begs the question, why then sell your gold for these dollars?
DIA’s view is that gold is not an appropriate asset for a long term investor in any amount, and Warren Buffet agrees (see his 2011 letter to shareholders). There are better ways to diversify a portfolio such as in real estate (which shows a better track record of protection against inflation versus gold), foreign stocks, and foreign currencies. To protect against inflation and a weakening dollar, owning Swiss Francs is a possible alternative. An investor can own Swiss Francs simply by purchasing the ETF (Ticker: FXF), which is up 4.5% per annum since 2006 (and outperformed gold in 2008). When you buy gold, you are speculating, which is not necessarily bad if that is your goal. But like any speculation, gold can plunge as fast as the hedge funds who dabble in it can hit the sell button.
Note that this article was written to provide information and education, and is not intended to be considered investment advice, which can only be provided by DIA following a consultation and execution of an Investment Advisory Contract.