Gold. Seemingly everywhere investors look nowadays, they’ll hear someone talking about putting money into gold — how it acts as a safe asset that hedges against inflation, does well during periods of extreme turmoil and uncertainty (hello, 2020), isn’t correlated with the stock market, etc.
But the real question here is, are there any merits behind these claims, and does gold deserve a place in a portfolio? In the midst of uncertainty with the COVID-19 pandemic and in the wake of the presidential election, should you be dedicating some of your hard-earned savings and investment gains toward an asset class that has historically been referred to as a “pet rock“?
What are the considerations to keep in mind when thinking about investing in gold?
To start, let’s think about two of the most fundamental aspects of any investment: intrinsic value and cash flow. In short, gold doesn’t have any of either.
At its core, gold differs from stocks and bonds because it doesn’t generate any income, cash flows, dividends or interest payments. Gold investing, in its purest sense, is the epitome of speculation. Investing in gold, and pure commodities in general, is making a bet on the price movement of that commodity — you’re betting that someone in the future will be willing to pay a higher price than you did, and you’re accepting the opportunity cost of not receiving any income streams from that investment.
On the flip side of this, equities have revenue and profit streams that can flow out to investors as dividends, bonds have a coupon and stream of interest payments (while also being typically used to reduce portfolio volatility), and both of these assets have an opportunity for capital appreciation. For argument’s sake, if you were to purchase 10 bars of gold as a long-term investment and put that gold in a vault in your basement, 10 years later when you go back to look at the gold, it will still only be 10 bars. You won’t have additional gold, and you won’t have received any money or income from the bars either.
Many “pundits” will also tout gold’s ability to act as a hedge against inflation and strong long-term return as reasons for giving it a significant weight within one’s portfolio. However, as we can see below, from 1970-2019 gold was about 15 times more volatile than inflation, was more volatile than the global stock market of developed countries (represented by the MSCI World Index) and produced a lower annualized return than the global stock market. This can largely be explained by keeping in mind that when looking at gold’s long-term return, gold’s growth has mostly been limited to unpredictable, isolated periods of increased demand.
Exhibit 1: Performance statistics, January 1, 1970–December 31, 2019
|Annualized return||Annualized standard deviation||Average monthly return|
|Gold spot price||7.81%||19.80%||0.79%|
|U.S. Consumer Price Index||3.91%||1.29%||0.32%|
|MSCI World Index (net div.)||8.84%||14.55%||0.80%|
Source: Dimensional Fund Advisors. Past performance is not a guarantee of future results. In USD. Source of Gold Spot Price is Bloomberg. Source of U.S. Consumer Price Index is Bureau of Labor Statistics. Source of MSCI World Index (net div.) is MSCI. MSCI data copyright MSCI 2019, all rights reserved.
If we instead looked at these return figures starting in January 1975, which is when the government removed ownership restrictions and U.S citizens were free to directly own gold for the first time, the annualized return for gold actually gets cut to 4.76%.1
Even if we were to look at a shorter timeframe, while it’s true that the price of gold has increased, over the last 30 years gold has been outperformed by both the S&P 500 and the U.S. broad bond market (represented by the Bloomberg Barclays US Aggregate Bond Index which tracks investment grade corporate debt, as well as government debt, mortgage-backed securities and asset-backed securities).
Source: Callan PEP Database. The information herein is believed to be reliable, but accuracy and completeness cannot be guaranteed. It is for information purposes only and should not be used as, or as a substitute for, financial, investment, or professional advice. Charts and graphs cannot by themselves be used to determine when to buy or sell securities, and the information contained herein is not a solicitation to buy or sell securities. Past performance is not indicative of future results. Results shown do not account for investment management fees, transaction fees, custodial fees, or other fees or the impact of taxes, the occurrence of which would materially reduce results.
While it may not come as a surprise that the S&P 500 outperformed gold over this period, it’s important to talk a little further about the bond outperformance. As we can see from the graphic above, this bond outperformance came hand-in-hand with significantly less volatility than we saw with gold investments (represented by both the S&P GSCI Gold Total Return index, which tracks the CME Group’s gold futures prices, and the SPDR Gold Shares ETF – GLD, which is one of the largest physically backed gold exchange traded funds in the world and is listed on the NYSE). This is important to remember because in that same period of outperformance, bond investors were also receiving income payments while likely having a smoother ride along the way.
To provide additional context on the diversification benefits of fixed income, here’s a graph comparing the worst year return for bonds (1994 at -2.92%) compared to the worst year for stocks (2008 at -38%).
Source: PIMCO, as of December 31, 2019.
This is why, when we think about ways to mitigate risk within a portfolio, rather than investing in a speculative investment like gold, investors can often benefit from instead investing within a low-cost, globally diversified portfolio of stocks and bonds, while also investing within tax-efficient vehicles when applicable.
We saw this benefit first-hand earlier in the year during the extreme market volatility of March. Investors who held bond investments were able to see it act as a buffer to the stock market volatility. Additionally, investors who stuck to rebalancing their portfolios set themselves up to benefit from the subsequent rebound experienced in the second and third quarters of 2020.
If you have any doubts or concerns about your investment portfolio, then perhaps your current allocation isn’t right for you. It may be worthwhile to think about different investment strategies you can use to take some of the risk off the table, but while also providing you with income streams moving forward. If you’d like to discuss your concerns in more detail, please reach out to one of our financial advisors.