With the exception of perhaps Bitcoin, there are few investments as polarising as gold.
Warren Buffet once said that “anyone watching from Mars would be scratching their head,” about why humans invest in gold. He’s generally avoided physical gold since it has no utility value (although in 2020, he invested in gold miners).
Ray Dalio, the billionaire American hedge fund manager, who is the chief investment officer of the world’s largest hedge fund (Bridgewater Associates) preaches the opposite, saying that gold should be part of everybody’s portfolio because it’s an alternative to money.
“If you don’t own gold… there is no sensible reason other than you don’t know history or you don’t know the economics of it.” – Ray Dalio
Views on gold as an investment are generally philosophical rather than fact based. Gold is a difficult asset to value, and market commentators love to speculate what is causing the daily moves.
Unlike other commodities like iron ore or oil, there’s little industrial use for gold. It doesn’t power our smartphones or enable the production of steel for buildings. The majority of the demand for gold in the world comes from either jewellery or investment. So when investors buy gold they are investing in an asset whose major use is simply as ‘an investment’ – and not much else.
Unlike shares and bonds which generate dividends, gold doesn’t generate regular cash-flows so investors in gold can only benefit from capital returns.
Why Stockspot invests in gold
Stockspot Portfolios have included an allocation to gold via the GOLD exchange traded fund (ETF) since 2014. The GOLD ETF is physically backed by gold bullion which is stored in a vault in London. It’s unhedged so investors also benefit from a falling Australian dollar.
If we only focussed on gold having little utility and an inability to generate cashflow, then the decision to include gold in our portfolios might seem strange – especially when it drops in value (as any investment is will do from time to time).
If we dig a little deeper though, gold is crucial to the long-term health of your investment portfolio. It’s a defensive asset, and it’s a better diversifier than cash or any other readily investable asset class. That’s why Stockspot includes it as part of our portfolios.
Increasing our gold allocation
In late 2017 we increased the GOLD ETF allocation from 10% to 12.3% for all client portfolios because we identified the need for more exposure. The negative correlation between shares and bonds had weakened, which meant that bonds wouldn’t provide as much of a cushion in a share market correction scenario.
Increasing our allocation to defensive assets in 2017 helped protect clients from 50% to 80% of the market falls in March 2020 and the gold allocation has generated much of the outperformance compared to similar funds.
Increasing our allocation to gold in 2017 helped cushion the blows of 2020, with gold being the best performing asset class in a year fraught with share market volatility.
During the first half of 2020 the unpredictability of the share market – not seen since the 1987 crash – led to investors seeking a defensive asset to protect their wealth.
Gold performance & price
In 2020, gold had performed better than most investments over the previous 2.5 years, including Australian and global shares. Gold notched up a return of 62% and made headlines during the COVID-19 market correction in March 2020 with an all-time high price of US$1966 (AU$2,750) per ounce.
More reasons to own gold
1. Gold is a diversifier
Harry Markowitz won the 1990 Nobel Prize in Economics by showing how to achieve the best return potential by combining assets with a negative relationship to each other (negative correlation).
His seminal work, Modern Portfolio Theory (MPT), continues to be the best regarded theory for managing portfolios, and is how we approach building portfolios.
Gold has a very low or negative correlation with most other investment assets which is why it typically moves in a different direction to shares. This is a rare quality for an asset and it means that gold has the ability to reduce the risk of a portfolio.
Essentially, gold helps to improve the quality of your investment portfolio returns which means you can earn returns with less risk.
2. Gold is an insurance policy
Gold has historically been an effective way to preserve the real value of your wealth since it acts as an insurance policy against currency devaluation.
Currency devaluation happens when your home country currency loses its global purchasing power either because of economic factors or monetary policy.
In 2020, gold was trading at its all-time high in both Australian dollars and US dollars. More recently gold prices have fallen as share prices rise and interest rates start to rise. However, if inflation accelerates quickly and currencies start to weaken, gold will likely be a sought out asset class.….
3. Gold is a safe haven
Gold tends to be viewed as a safe haven, because when other assets like shares are falling, gold often rises. This helps to cushion the impact of share market falls.
Government bonds have historically been one of the safest places to park your money. Today , however, there is a record US$16 trillion of government debt issued by creditworthy governments that trades on negative yields. In countries like Japan, Switzerland and Germany you need to pay the government to borrow your money.
While gold doesn’t have a yield, it’s still a more positive yielding asset than negative yielding government bonds which penalise owners. As the amount of negative yielding government debt increases, so too does the attractiveness of gold.
It’s just smart to own gold
Gold is a key portfolio diversifier, regardless of your investment horizon or risk capacity. It’s even more important for growth focused investors right now since shares and bonds are dancing to the same tune.
Gold has historically been able to maintain its purchasing power and provide portfolio insurance in times of need. It will continue to benefit from the swelling pool of negative yielding government debt and central bank quantitative easing (QE) programmes.
It’s the part of your portfolio you’ll be glad you have when the rest of the investment world isn’t shining.
This article was originally published in July 2019 and has been updated in April 2021