Gold: The New Sexy
Technology, China, Real Estate, now GOLD.
There has been a lot of noise lately about the wisdom of using gold in client portfolios. As usual, the proponents of using gold make it sound as if buying gold is an obvious, easy decision and that those portfolios which don’t hold large positions in gold are simply not aware of its amazing benefits.
As Chief Investment Officer at Redwood, my job is to protect and grow our client accounts and so I would like to restate our position about gold.
The current popular contention is that you should buy gold to protect your portfolio from an inflationary environment since other types of investments like stocks, bonds, and real estate will severely underperform in such an environment.
Many economists believe (though many do not) that we are about to enter a period of large increases in inflation. So it should be obvious, according to gold proponents, that gold should be a large percentage of one’s portfolio in 2009.
So let’s examine Gold’s recent performance as an inflation fighting tool.
In 1978, inflation jumped to 9% (1) from the decade low of 3% in 1971. By the end of 1980 it was as high as 13%. So, according to the same people now touting gold, in such a hyper inflationary period, stocks, bonds, and REITS must have performed terribly.
However, from 1978 to 1980, when inflation was at its peak, the bond index increased over 10% (2), Real Estate Investment Trusts were up 100% (3), and the US stock market was up over 50% (4).
At the same time, gold hit its high of $850 in January 1980, and then immediately started collapsing with the price falling almost 44% in the following two months. Like all commodities, the price of gold can fall just as quickly as it moves up. Trying to time the peak is virtually impossible.
So an investor who bought gold in January of 1980 immediately saw the value of his holdings drop by 44% in just two months.
Gold did not reach the $850 price level again until January of 2008, almost – 30 years later! In the same time period, the price of goods we buy everyday (inflation) increased almost 170%.
Thus, gold did not provide much inflation protection during these times and we do not recommend holding it now.
To summarize, we do not believe that, long term, gold provides a sufficient return. It becomes very popular during distressed economic times and when there is an expectation of hyper-inflation. However, as we have said in the past, it is purely a speculative “bet” and is not a good long term investment.
In fact, the data shows that return on gold only averages about 3% a year or roughly the average amount of inflation but is prone to large swings in value which make it a less than ideal tool for hedging against inflation.
My favorite quote is from Gary Brinson, “an ounce of gold bought a fine men’s suit in the time of Shakespeare, and so it does today.”
(1) Represented by Consumer Price Index for all Urban (CPI-U), not seasonally adjusted – Source: DFA Returns 2.0
(2) Represented by Barclays US Aggregate Bond Index – Source: DFA Returns 2.0
(3) Represented by Dow Jones Wilshire REIT Index – Source: DFA Returns 2.0
(4) Represented by Russell 1000- Source: DFA Returns 2.0
