"Talk me out of allocating to gold."
We have always invested in productive assets - stocks and bonds that earn money or pay interest to their investors. Gold is a speculative asset - its value depends on someone willing to pay more for it in the future. While gold has not been a part of our portfolios for over a decade, we are reintroducing a small allocation this year and believe gold plays a role in a diversified portfolio at this time. Why now?
Gold is variously cited as a hedge for many things that threaten portfolios: inflation, market volatility, interest rate volatility, geopolitical conditions and more. Looking specifically at market risks, gold mitigates some of the risk in large market pullbacks.
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| SSGA Gold Team. (2019). The Role of Gold in Today’s Global Multi-Asset Portfolio. https://www.ssga.com/library-content/pdfs/etf/us/b30-spdr-the-role-of-gold-in-todays-global-multi-asset-portfolio.pdf |
While the world has always had risks, they appear to be rising now. Gold is viewed as a safe haven asset in times of volatility and uncertainty. With fast changing policies, less positive economic data and uncertainty on interest rates, a safe haven asset is attractive.
This table from Wisdomtree shows the performance of Gold through different financial and geopolitical crises:
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| Wisdomtree. (2020). The Investment Case for Gold. https://www.wisdomtree.eu/en-gb/-/media/eu-media-files/other-documents/research/strategy-insights/wisdomtree_strategy-insight_the-investment-case-for-gold_eng.pdf |
Importantly, gold is not just a speculative trade for the moment but an asset that keeps portfolios diversified through turmoil. A quilt chart of asset class returns illustrates this point well. No single investment is the best investment every single year, but over time, a diverse portfolio performs well with less risk.
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| Oppenheimer Asset Management. (2023). Market Strategy Radar Screen. https://www.oppenheimer.com/seldonclarke/assets/pdfs/market-strategy-radar-screen-aug-2023.pdf |
There are investors who believe in a permanent strategic allocation to Gold. Matthew McLennan of First eagle likened it to the capital that a bank needed to keep on hand to weather any storm. The Global Fund that he manages currently has a 12% allocation to gold. They maintain a strategic allocation to gold as “differentiated risk-return characteristics have enabled it to maintain its real value across disparate macroeconomic environments and through existential disruptions to markets.” The Permanent portfolio has long held steady with their fixed 20% target allocation to gold. None other than the World Gold Council once recommended a more modest 5-6% allocation.
Investing in gold is not risk free. For that reason, I do not view this as a permanent, strategic allocation. Gold is a non-productive asset that depends on finding a buyer at a higher price. It does not pay interest or dividends. It does not produce goods for sale and manage expenses like a well-run company. We use bonds to address those short-term cash needs. We invest in stocks to grow our assets far into the future.
We often cite investment in growing stocks as a way to keep ahead of inflation in portfolios. Historically, gold has performed as an inflation hedge also. The last two and a half years have seen both the inflation index and gold rising in tandem:
Uncertainty surrounding inflation, market volatility, interest rate volatility, and geopolitical conditions convinced me to add this asset to the mix. While I certainly do not hope for an uncertain and dangerous world, an investment in gold may be a small way to address the risk that the world is not so rosy in the future.
Gold is an investment whose returns are not correlated with, nor depend on returns from stocks and bonds that make up the bulk of your portfolio. It provides some sense of a safe haven in the face of uncertainty. Ideally for investors, a clear, optimistic economic picture will emerge, stocks will gently rise and gold will fade to obscurity. If that doesn't happen, we want to be prepared.
Lastly, we cannot make an allocation change without being very sure of the investment we are selecting. There are many funds that hold actual physical gold in vaults. This provides the purest exposure to the price changes that we are looking for - equivalent to (but simpler than!) holding it in your own hands. An often-overlooked aspect of selecting a fund is how easily we can buy it. We narrowed the list down to the funds that have low trading costs - after all, every dollar we can save on costs is a dollar that stays in your pocket. For cost and ease of buying in your portfolios, we have selected GLDM.
