The Case for Gold

Updated: Sep 14, 2021

"Gold is a polarizing asset.  Investors either love it or hate it, but rarely does the opinion lie in the middle.  No matter what your view on gold, we find the investment case for the yellow metal particularly interesting at this juncture in the economic cycle." - Pure Portfolios, Allure of Gold (May 17, 2017).

When I wrote "Allure of Gold" back in May 2017, there wasn't much fanfare around the yellow metal. The U.S. stock market was up and Gold was clunking around not doing much...

Source: Ycharts

The above chart shows the S&P 500 (via ETF SPY, orange) and Gold (ETF SGOL, purple) from July 2014 to July 2017. There was little reason for investors to find gold appealing, the market was rising and the yellow metal was volatile with little to show for it.

I'm having more conversations about gold than I can remember. Not coincidentally, gold has been a stellar performer as 2020 proves to be one of the oddest years on record.

Source: Ycharts

The above chart shows the S&P 500 (via ETF SPY, orange) and Gold (ETF SGOL, purple) year to date (through 7/29/20). Gold has proved to be a safe haven and then some, appreciating 29% in 2020. Investor interest in the yellow metal has spiked. Everyone loves a winner.

We revisit our case for owning gold (which has nothing to do with recent performance) and why it should have a place in diversified portfolios.

Government Spending & Monetary Policy

Source: Ycharts

The above graph shows M2 Money Supply growth year over year. The Fed has lowered interest rates and increased the money supply to mitigate economic pain from the pandemic. Increases in money supply have often been associated with inflation, but the relationship has become less stable post 2000.

Source: Ycharts

The above graph shows US public debt levels. Government spending has ballooned as the U.S. Treasury has provided direct relief to American business (PPP program) and households (direct payments and increased unemployment benefits).

While these are unprecedented times, the overall trajectory of US debt and monetary policy is not sustainable. As governments around the world become more indebted and fiscally irresponsible, investors would be wise to seek out currency that cannot be manipulated. A bureaucrat cannot produce more gold nor increase the supply overnight. Gold is massively appealing, in our opinion, in a era of fiscal stimulus and monetary policy experiments.

Gold Acts Differently

In the context of a diversified portfolio, you want assets that behave differently. We have written about the perils of fake diversification, assets that produce small gains and large losses, and turning safe into risky

There's nothing worse than thinking you are diversified, only to find out everything in your portfolio moves down together (which tends to happen during times of stress).

Source: Portfolio Visualizer

The above graphic is a correlation matrix for various asset classes from 2009 to 2020. (it also has the potential to make your head spin). It shows how each asset moves in relation to another. Pay attention to the bottom highlighted area - Gold (ticker GLD) has a very low correlation to various U.S. stock indexes (0.10, 0.11, 0.09). This is true diversification. Note: a correlation of 1 would mean two assets move perfectly together.

In my opinion, gold is polarizing because a) it doesn't produce cash flow making it difficult to evaluate, and b) people get caught up in evaluating gold in a silo. For example, if gold is down for the year, a novice investor might conclude it to be a lousy investment.

To understand the merits of gold, one should evaluate it within a total portfolio context. In general, any asset class with a low correlation to a portfolio's risky holdings (stocks) should improve the risk/return profile of the portfolio.

Low Interest Rates

Zero percent interest rates look like they're going to be around for some time. Hence, the opportunity cost for owning gold is low. An investor is not forgoing outsized interest income because there isn't much to be had.

Source: Ycharts

The above graph shows the Fed funds rate (blue line) and Gold (ticker SGOL) since August 2010. You can see the strong relationship between low rates and higher gold prices and vice versa.

Understanding why you own something and its role in the portfolio helps avoid making poor investment decisions. For example, if someone was evaluating the merits of Gold based on performance from 2014-2017, you would likely have punted or decided not to purchase.

When you add up the pieces of the puzzle (safe-haven currency, reducing risk in a diversified portfolio, and rock bottom interest rates), the case for gold is quite strong.

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