“When we have gold we are in fear, when we have none we are in danger”
Gold is often considered the ugly duckling of investing, we think, unfairly. Gold doesn’t generate cash flow; it exhibits some volatility with prices often moving in fits and starts. But, from a portfolio manager’s perspective, the reason for adding gold to a portfolio is the lack correlation to other asset classes. That’s just a fancy way of saying that gold reacts to a variety of risks in ways that are different from other assets. The price of gold responds to inflation, financial stress, and interest rates, to varying degrees depending on which of these factors is of the greatest significance at any particular time. At least one of those reasons exists virtually 100% of the time, which is why gold is a staple on our portfolio models.
Gold may no longer be the most misunderstood asset of modern times (crypto and non-fungible tokens have the lead on that score), but the value of gold has been confirmed for thousands of years starting with Kings and today by central banks. The role of gold in a portfolio has evolved over time and that might well be the most impressive quality of gold – it’s ability to transcend thousands of years of the evolution of civilization, yet still remain relevant.
Gold as an Inflation Hedge
At times gold acts as an inflation hedge and the price reacts strongly to changes in inflation, yet at other times it seems to not care about inflation at all. Case in point: if you look at price of gold, adjusted for inflation on the chart below, even adjusted for inflation, the price of gold has been quite volatile so there is more to gold than simply as an inflation hedge. But although the price of gold doesn’t consistently reflect inflation, over a long time, it often does. In 1930, a kilo of gold could buy you a new Chevrolet. Today, a kilo of gold will still buy you a new Chevrolet! Is gold an inflation hedge? Over the long term it has been a very reasonable inflation hedge, but over shorter time frames, it may or may not be an effective hedge, depending largely on which factors are influencing the price of gold at any particular time.
Gold as an Insurance Policy
There are times when gold acts as a financial insurance policy and reacts to financial stress in the economy as well as markets. World class investor Warren Buffett once said “Gold is a way of going long on fear”. We experienced a recent example of that as the COVID pandemic broke out in 2020 and gold held up much better than most other asset classes.
In times of stress, the value of stocks and traditional investments come into question. Gold has long been the reliable store of value when the value of other assets is questioned. As a result, when the world worries, the gold price tends to rise as the ‘cost of insurance’ increases. Yet at other times, that insurance appears to be unnecessary and the linkage to gold is broken — until the next round of stress. In our view, the need for insurance as global debt levels continue to rise to new heights is more pronounced.
Gold as a Speculative Asset
There are also times that gold acts as a commodity purely for speculative reasons. Unlike most other commodities, gold has few industrial uses. Its primary use is in jewelry, and even in that case, jewelry can simply be considered an alternative method of storing gold. As a speculative asset, gold competes with other assets for the attention of speculators and that implies that the level of interest rates and other cash on cash returns, like dividend yields, create a headwind for gold speculators because gold has no yield. The higher interest rates go and dividend yields go, the less attractive gold is to speculators. It’s simply easier to make a case to own gold when interest rates are near zero, as opposed to 6% or 7%. As a result, in the very near term, gold often trades based on changes in interest rates with higher rates pushing gold lower and vice versa.
Gold as an Asset Class
The great part about gold is that when all of the above are combined, we have an asset class with little correlation to other asset classes and over time, attractive positive returns. That makes a gold not only a strong asset for stressful times or inflationary times, but for all times.
“Gold is the money of kings, silver is the money of gentlemen, barter is the money of peasants – but debt is the money of slaves.” Norm Franz
What We’re Reading
John Deere breaks new ground with self-driving tractors controlled from a phone
Central Banks Can Shape the Future of Digital Finance
Bitcoin slumps to a three-month low as cryptocurrencies extend losses
The Federal Reserve is scaring markets with the triple threat of policy tightening
Four experts give their initial reaction to December’s major jobs report miss
Prediction Consensus: What the Experts See Coming in 2022
A Look at Putin Through the Soviet Lens
Biden’s Moment of Truth in Iran
Titans of Carmaking Are Plotting the Overthrow of Elon Musk
Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.Asset Allocation, Asset Classes, Commodities, Gold, Hedging Risk, Inflation, Interest Rates, Portfolio Diversification, Speculation, Volatility
Articles, General News, Weekly Commentary