Gold is often considered a haven, providing protection against inflation, market crashes, social disorder, and the potential collapse of a major currency. In our view, it is not suitable for inclusion in your portfolio. Gold is often believed to have an inverse correlation with stocks and a positive correlation with inflation, making it an attractive asset for diversification in investment portfolios. It’s important not to let superficial things deceive you.
Investments can be categorised into four distinct groups:
- Cash-generating assets
In what category does gold belong?
Gold’s utility in industrial manufacturing is limited, leading to its classification as a commodity. It can also be part of your collection. Nevertheless, both factors do not significantly influence the demand for gold. Gold is frequently used as a means of preserving wealth. In essence, individuals purchase gold with the expectation of selling it later for a greater value. It does not generate cash.
What is inflation protection?
Since 1975, when the United States ended the gold standard and allowed citizens to own and trade gold, it has been observed that gold does not effectively protect against inflation in the short or long term. This is primarily due to the volatility of its real price up until March 2012.
There is a positive correlation between the Consumer Price Index (CPI) and the average price of gold. Comparing the inflation-adjusted gold price with the actual gold price has shown infrequent similarities.
Investors should explore alternative asset classes to address concerns regarding rising consumer costs. When analysing the performance of different asset classes during periods of above-average inflation, it is evident that gold does not serve as a complete hedge.
There is no guarantee that an increase in inflation will result in gold generating returns that are higher than average. Gold’s performance during past periods of inflation has been inconsistent.
Gold can be an effective means of preserving purchasing power when faced with a debt that is due in a distant future, such as 2,000 years. Gold has historically served as an effective hedge against inflation in relation to military pay, dating back to the time of Emperor Augustus’ reign from 27 BC to 14 AD. Gold is not an effective hedge against short-term inflation, whether it is expected or unexpected, under normal circumstances. Gold has the potential to serve as a reliable safeguard against inflation over an extended period. The long run may exceed an investor’s time horizon or lifespan.
On January 21, 1980, the price of gold reached a record-breaking level of $850. Gold was priced at $293 on March 19, 2002, which represented a substantial decrease compared to its value two decades prior. The annual inflation rate from 1980 to 2001 averaged 3.9%. Gold experienced a significant decline in its purchasing power, amounting to approximately 85%. Despite gold’s 85% decline in real terms over the past 22 years, it is still regarded as an inflation hedge.
Nevertheless, individuals purchase gold for reasons beyond just hedging against inflation. One primary reason is the perception that it is a secure sanctuary. In times of failure, this asset will demonstrate its superiority.
Is gold widely regarded as a safe-haven asset?
Gold returns were positive in 83% of instances when stock returns were negative. The track record is not significantly negative. The correlation between the gold spot price and the MSCI All Country World Index from 1988 to 2019 was 0.085, indicating a relatively low but non-negative relationship. This is contrary to the expectation that gold, as a safe-haven asset, would exhibit a negative correlation with stocks. During the financial crisis, gold prices experienced a decline of over 30%, rendering the hedge ineffective despite its necessity at the time.
Gold outperformed stocks and bonds in 2022, but it did not effectively serve as a hedge as its value declined marginally from $1,829 in 2021 to $1,824 in 2022. During the global market decline in 2008, gold experienced a modest increase of 5.53% in US Dollar terms, which can be viewed as a positive outcome. US government bonds increased by approximately 14%.
A challenging experience.
The perpetual reliability of gold as a safeguard against stock market declines is not apparent. Assets with a low correlation to stocks are valuable additions to a portfolio. However, it is important to acknowledge a significant concern regarding gold: while its correlation to stocks is low, its projected returns are uncertain.
Gold maintains its intrinsic value, which is determined by the price individuals are willing to pay for it. There is a possibility that the asset will maintain its actual value, indicating an expected return of zero after adjusting for inflation. However, it has exhibited significant volatility in its actual value throughout history.
The gold spot price exhibited a standard deviation of 15.43% from 1988 to 2019, while the MSCI All Country World Index had a standard deviation of 14.85%. Gold had a pre-inflation return of 3.43% during the same period, while global stocks had a return of 7.85%.
In summary, gold exhibits higher volatility compared to stocks yet offers lower returns. Therefore, due to its limited correlation with equities and absence of anticipated returns, incorporating gold into a portfolio poses challenges.
What is the opportunity cost associated with allocating a portion of one’s funds to invest in gold?
Gold does not possess a genuine anticipated return. Gold has historically shown strong performance during periods of stock market decline. However, there are other diversified investment options that offer better projected returns while achieving similar outcomes.
Being considered a safe place on paper does not guarantee the preservation of the owner’s wealth during a real catastrophe. Transporting gold in such situations is challenging, and a gold exchange-traded fund (ETF) would also prove ineffective. Gold enthusiasts typically do not consider it a viable long-term investment. Instead, they perceive it as a means of safeguarding against severe events such as hyperinflation in the long run.
A country’s inflationary situation has no bearing on gold returns. Gold may experience significant negative real returns in a hyperinflationary period, showing little concern for such circumstances. The expectation that gold will maintain its purchasing power or generate positive real returns solely based on a country’s experience of hyperinflation is unfounded.
Gold lacks utility as an asset.
The expected return is zero. While it is possible for it to keep pace with inflation over time, the duration required may exceed the patience of the majority. Due to its low correlation with financial assets and lack of expected return, gold is not suitable for inclusion in a portfolio. Although inflation does not directly affect gold’s purchasing power, this does not necessarily mean that it will do so. This raises concerns about its effectiveness as a hedge against significant currency fluctuations.
Gold dealing is a topic worth discussing.
There are proponents who argue that actively trading gold can be more advantageous than owning it. This assertion holds validity, as it applies to other non-productive assets like Bitcoin. However, Expat Wealth At Work do not engage in the trading of strategies. Numerous YouTube channels exist that focus on teaching gold trading strategies. However, it is unlikely that any of these channels provide scholarly references, unlike the research we have incorporated into this content.
Interpret the information as you see fit.