Is now a good time to buy Gold?
Key takeaways
- Gold is a controversial topic and there is a lot of misconceptions about Gold andĀ facts that may surprise you
- You may be surprised thatĀ owing Gold is RiskyĀ –Ā it can be a very volatile asset on its ownĀ
- On top of that,Ā Gold is prone to short term sell-offs during a crisisĀ at exactly the same time as Stocks – this is due to market-wide liquidationsĀ
- However, Gold works really wellĀ within a diversified Portfolio and offers good diversification with no correlation to Stocks in the long term
- Gold reacts well within longer periods when Stocks under-perform and will hedge your portfolio
- Don’t get emotional about GoldĀ and over-concentrate in GoldĀ like some doomsayers/goldbugsĀ would encourage you to do but treat it like anĀ insurance for extreme risksĀ
- WhileĀ sub-optimal compared to Bonds as safe havenĀ (outside of some unlikely but high impact events)Ā Yields are currently so lowĀ that it is reasonable to considersĀ Gold asĀ a partial alternative. Here is why.
- For disclosure, given where yields are, I currently have over 10% of my portfolio allocated to Gold
The Ultimate Currency
A Bloomberg Terminal used by bankers and colored asset classes on its keyboard
- Gold is a currency and a commodity (to a marginal degree)
- It’s a controversial asset – some Finance people I know avoid it while a lot of traders allocate a substantial amount of their savings to Gold.Ā It can get emotional. People in banking are pretty rational, unless you talk to them about Football or Gold
- For the Finance community it’s a currency, the ultimate currency. In fact Financial Analysts using a Bloomberg terminal must enter ‘Currency’ after typing the Gold ticker to get information about it or its latest price
- Aswath Damodaran, one of the most respected academic asset valuation researchers summarized it follows: “Goldās value has more to do with itsĀ longstanding function as a store of value,Ā especially during crises orĀ when you lose faith in paper currencies, it is more currency than commodityā
- Gold is also a commodity as technology companies use it in industrial processes – but the demand is marginal.Ā Ā According to the World Gold Councilās data, it accounts only for about 17.5 percent of the total demand for gold
Gold's historical value comes from difficulty of acquisition
Gold as Proof of Work (perĀ Joe Weisenthal)
One of the striking things about gold is just how incredibly hard it is to attain (and hold onto once you have it) and the different things you have to master to get gold
To get Gold you:
- Have to be good at warfare
- Be able to marshall an extensive human workforce to mine it
- Mastery of global supply and logistics routes
- Be able to command guards who will watch your gold, and not steal it
- Have the technical know-how to get gold out of the ground, which is expensive and
cumbersome
When you have gold youāre communicating all the different things youāre capable of (mastering supply routes, commanding an army, scientific endeavor, marshalling labor, etc.)
Gold, then, is a very specific proof of work. If you can get gold, youāve proven that you have the ability to run a state or some state-like entity
As with all currencies, Gold has no yield on its own
- Unlike bonds, gold does not pay interest or dividends
- This perceived lack of yield often deters some investors
- It also does not have credit riskĀ
- You also need to account for storage costs
The Bad - Gold is Risky
- Despite popular safe haven belief Gold is inherently risky – especially for people that don’t diversify enough and have a high concentration of their wealth in GoldĀ
- On its own, Gold is a volatile asset – in fact, if held for 5 years you could still have faced up to a 40% loss on several occasions over the past 3 decades
- The below graph illustrates Profit / Loss for $1000 invested in Gold and held for 5 yearsĀ Ā
- However, Gold acted as a great long term Equity hedge during the GFCĀ
- You can see that there is aĀ short term sell-off period for Gold in the middle of the 2008 Crisis (circled in yellow below)Ā – despite its safe haven status liquidations of assets have short term impact on GoldĀ
- Gold has returned up to 280% in 2010/2011 if bought 5 years earlier and held for that same 5 year period
Net Profit & Loss at the moment of sale on $1000 invested in Gold 5 Years earlier (5 Year Holding Period)
Don't try to time the market
- Price moves are of course even more extreme if you invested at the top of the market
- The below graph gives you a long term perspective on how Gold can have decade(s) long under-performance
- Gold peaked at the beginning of the 1980s and faced long periods of under-performance
- It subsequently recovered from 2000 onwards and peaked again in 2011
- Recently, Gold has rallied since mid-2018
Lost decade(s) - Net Profit & Loss on $1000 invested in Gold from its previous market peak
The Good - in a Portfolio, Gold combined with Stocks works really well
- Gold provides very good diversification benefits – only inferior to Treasuries but Yields are currently so low that holding Gold has low opportunity costs
- You may also need more risk tolerance and not react impulsively – Gold will help you to rebalance your portfolio during a crisis but this may not be as immediate as Bonds due to market-wide asset liquidations
- Read what diversification means and how to read the below tableĀ
Gold Portfolio Diversification Benefits 1999-2019
Understand how portfolio diversification works
Here is a guide on how to select assets for your portfolio. Simplify your portfolio by following these allocation strategies to improve performance and time you need to dedicate to portfolio management. Understand how to clean up your portfolio from asset classes you donāt need
OK, but what moves Gold Price and why is it good for my portfolio?
- As with all diversifiers, Gold will help you to re-balance into cheaper Stocks when you need it
- There were/will be scenarios where other asset classes will underperform and you may then use sale proceeds from Gold to purchase other cheaper assets that generate yields/dividends
- You don’t have to understand the technical details to be able to benefit from Gold – in fact diversification is all that matters. However, it’s good to have an understanding of what really makes it a different asset and when you may need it (of course, I assume that no one can get the timing right)
Not Gold vs Bonds but Gold & Bonds
Net Return on $1,000 from a 70% International Equity Portfolio and 30% Gold or Bonds over 5 years at time of sale (5 Year Holding Period)
- The above chart represents a return in USD (before fees) from holding a 70% Equity 30% Bonds or Gold Portfolio over 5 years time at the time of selling the investments (assumed 5 year holding period)
- Bonds provided better overall returns up until the Global Financial Crisis but since then Gold resulted in higher Portfolio returns
- Remember, that Gold is much more volatile (15% Risk as measured by standard deviation vs. 3.5% for Bonds) and your overall portfolio risk in the example above increased as wellĀ
- It confirms thatĀ you should have both Bonds and Gold in your portfolio since the protection benefits do not kick in at the same time depending on type of market eventsĀ
How to incorporate it into a Portfolio
Here is a guide on how to construct a Long Term Portfolio to reach your goals e.g. Financial Independence, Retire EarlyĀ
BONUS - What really drives Gold Price?
"If you don't own gold...there is no sensible reason other than you don't know history or you don't know the economics of it"
Current potential of key catalysts
#1 Opportunity Cost
How do I track opportunity cost?
You can easily track daily Real Rates from US Department of Treasury websiteĀ or the FED – the lower the rates the lower the opportunity cost of holding Gold (and higher its price)
Low Real Interest rates is the elephant in the room and drives most of Gold price
Investors are turning to gold because of one simple fact – deeply negative Real Yields (Treasury Bond Yields after accounting for Inflation)
The more Treasury Bonds are generating negative real returns the more attractive Gold becomes. After all, buying a bond that is guaranteed to lose you money is a tough sell
Gold price has moved in line with Real Interest Rates for more than a decade
According to aĀ BlackRockĀ analysisĀ Real Yields explain around 30% of the price of Gold ā the strongest factor, by far. But it is not true inĀ all environments when other price drivers take over
We could break it also down into three periods:Ā
- 1982-1999 (High Real Yields)
- 2000-2008 (Decreasing Real Yields) and
- 2009-2019 (Low Real Yields)
In the first two periods when Bonds offered positive / high real returns there was little or low relationship between Gold and Real Yields (it may be the case again if Real Rates go up one day)
That said, in the current low yield environment there is clearly a strong correlation between rates and Gold prices
Watch Real Yields closely
BlackRock estimates that a rule of thumb is that every 0.10% drop in Real Yields coincides with about a 1.25% increase in Gold Prices. Real Rates are already low hence any potential coming from Rates is by definition limited
#2 Dollar strenght
How do I track Dollar strenght?
You can easily track USD Strenght vs major currencies (predominately the Euro) by following the Dollar Index (DXY).
Essentially, this tracks how strong is the USD versus a basket of other currencies. A stronger Dollar vis-a-vis other currencies may mechanically weaken Gold
This reason is mechanical – Gold is quoted in US Dollars
- Thus, historically Gold outperformance is strongest when the Dollar is down. It’s valid over long periods of time. During Coronavirus both the Dollar and Gold were perceived as Safe Havens and a stronger Dollar didn’t have a major impact on Gold. This may revert as the Economy stabilizes.
- Monetary Inflation increases prices of all assets including Stocks and GoldĀ on the back of unprecedented stimulus by the FED which will make the USD relatively weaker (Price inflation of Real Assets since these are quoted in USD)
#3 Macro Shocks
As you may have observed during the COVID-19 Crisis, each Jobless claim on Thursday came with a surge in Gold Prices
Other Economic indicators have similar effect. Gold may ultimately react negatively to a more positive outlook.
Any potential geopolitical or Economic Conflict (e.g. Escalation of Trade War with China) may also impact Gold and provide a hedge to your Equity portfolio.Ā
There is also a possibility of other Tail Risks combined with current situation (remember how the Oil Price War escalated quickly). We just don’t know but Gold is an Insurance in these instancesĀ
#4 Very High Inflation
How do I track Inflation Expectations?
One of ways of tracking medium term inflation is using FED’s 5 year breakeven inflation rate
This graph will show you the expected annualized inflation over the next 5 yearsĀ
Gold performs well is sub 1% or above 3% Inflation
In terms of inflation regimes, average Gold returns have generally been most significant during extremely low (less than 1%) or high (greater than 3%) inflation.Ā
Is it a good time to buy Gold with inflation between 1% an 3%? In those episodes gold returns were lackluster (pun intended)
"I hate gold and I have always hated gold. Unfortunately, I own gold. I think I have two fears. One fear is deflation and one fear is inflation and I have learned through history that there is no such thing as inflation anymore. There is hyperinflation or nothing. Now we are in a deflationary environment. It can switch very easily from there because there is so much money out there. So I want to hedge and make sure my funds and my savings are unaffected by both deflation or hyperinflation"
When the 60 Stocks / 40 Bonds Portfolio doesn't quite work
- The real price of imported oil in the U.S. increased 6-fold in the 1970s, leading to runaway inflation and stagnant economic growth.Ā
- Initially, stock-heavy portfolios were hit the hardest, declining up to 50% within 18 months
- Later, as inflation accelerated, bond-heavy portfolios suffered as well, declining up to 40% by 1981 (inflation adjusted chart below)
Note that I used a separate axis (right) for Gold since it is so much more volatile compared to Bonds and Stocks (acts like an option aka insurance)
Oil and Inflation Shocks of the 1970s
In essence, we would need to see a significant jump in inflation for Gold to benefit materially.Ā
This has also not been the case post the GFC ā when gold has been frustrating to trade. The prediction that drove the post-crisis rally ā that quantitative easing would lead to high inflation ā did not play out. Gold tumbled to below $1,100 by late 2015. Bears can also point to the two-decade slump that followed a high in 1980
#5 Commodity, Retail and Central Bank Demand
How do I track Gold Demand?
One of ways of tracking demand is through the World Gold Council website and its quarterly reports
Gold has a traditional supply / demand market as commodity (technology) in Jewellery or protective asset demand from Retail / Central Banks. Demand for Jewellery may currently be the weakest aspect of current Gold appeal. This aspect is largerly driven by Emerging Countries and more specifically Asia (50% of overall Gold demand comes from China and India)
Despite initial signalling Emerging Countries’ Banks are likely to continue the long term trend for central banks to be net buyers of Gold post GFC
USEFUL RESOURCES
HOW TO INVEST IN GOLD
Research the appropriate ETFs based on your needs
- If you decide to invest in Gold you may consider physical gold or Gold ETF
- Only consider Gold in a diversified Portfolio (Read how can Gold fit in a Long Term Portfolio))
- I have done some research for you and the Largest Funds are listed below
- An investment in gold is easily done with listed products, like ETFs or ETCs (How are they different?) These investment products track the spot gold price closely, after taking management fees into account
- Performance vary by currency (Gold is quoted in USD and then converged into local Fund Currency)
- I have not included leveraged Funds (understand their risks)
- As of the May 2020 the below table Gold (XAU) price was up 12.22% Year to Date (in USD). So far,Ā SPDR Funds most closely tracked this performance in 2020
Large ETF Funds by Fund Size
Read More about those Funds (Tabs by Exchange)
Investigate Liquidity, Fees, Commissions and Taxes
- Check the size of the fund and liquidity ā it is usually preferable to stick to the larger vehicles that are more liquid (why liquidity matters)
- Low fees are the most cost-effective feature of an ETF ā make sure you select a low fee vehicle. Check the expense ratios from our dashboard or the ETFdb website and plug them here. You can compare the effect of fees on your overall returns using my ETF fee calculator. You may be surprised of the high impact
- How is the purchase or sale of an ETF going to affect your tax return? While U.S. based ETFs have many tax advantages, a foreign ETF may not be so tax-friendly and therefore not cost-effective. Tax implications vary from region to region
- Verify any commissions and fees charged by your broker
REFERENCES
- Dirk G. Baur, ‘Gold – Fundamental Drivers and Asset Allocation’, University of Western Australia (2013), Available at SSRN
- Jeffrey F. Jaffe, ‘Gold and gold stocks as investments’, (1989), Financial Analysts Journal
Popular Guides
My fundamental reviews of Equity ETFs and Asset Allocation include:
- Investor Checklist - Ready to Invest? Have a look at the checklist before buying ETFs
- How to build a Long Term Portfolio for Financial Independence - Guide to creating a Smart & Simple Long Term Portfolios with ETFs
- All you need to know about International ETFsĀ - including Developed vs Emerging Markets, Small vs Mid/Large Caps and country allocations with List of Best ETFs
- The Simplest Equity PortfolioĀ - Comparison of Best Total World Equity Index Trackers
- How to pick the perfectĀ ETF? - Investing in Europe is not quite the same experience as in the US but this guide will solve all your issues. Spoiler - don't use TER! (applies to US Investors as well)
- Which Assets do I need in my Portfolio? - Clean up your portfolio from assets you don't need. High Performance and low maintenance Asset Allocation Strategies
- How do I benefit from a market crash?Ā - In the long run no crash (including Japanese style) can derail you if you do it right
- How to Invest for Short Term goals?Ā - Medium Term Investing is more risky than long term portfolio - pay attention to the right asset classes
My fundamental reviews include:
- Spectacular Market Crashes - how much can you lose? How long will it take to recover? How to take advantage ofĀ the next recession
- What if my Broker goes Bust?Ā How to choose a Broker that is safe
- What is the best rebalancing method? How to increase returns and reduce risk by rebalancing your portfolioĀ
- What about currency risk? Should I hedge my Portfolio? - Hedge or not to hedge? Guide to hedging currency risk in your Equity and Bond ETFs
- Should you buy Gold? - Is it necessary to have an asset that generates no yield? What really drives Gold price?
- International and European Bond ETFSĀ - For Long Term International Investors Bonds are key to protect their Equity Portfolios
- USĀ Bond ETF Guide -Ā Comprehensive Review of Blend Bond Funds, Treasuries, Corporates, High Yield, Inflation Linked, Muni ETFs
- Top 3 Corporate Bond ETFsĀ - If you want to increase income buy these ETFs to invest alongside the FED [for US Investors only]
DISCLAIMER
All information found here, including any ideas, opinions, views, predictions, forecasts, commentaries or suggestions expressed or implied herein, are for informational, entertainment or educational purposes only. The information provided on Bankeronwheels.com is general in nature only and does not constitute personal financial advice
Before acting on any information contained on Bankeronwheels.com you should consider the appropriateness of the information having regard to your objectives, financial situation and needs, and seek professional advice where appropriate. Read the full disclaimer.
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Stay safe & healthy,
Raph
FAQ
Owing Gold is Risky ā it can be a very volatile asset on its own. Gold is also prone to short term sell-offs during a crisis at exactly the same time as Stocks ā this is due to market-wide liquidations. However, Gold works really well within a diversified Portfolio and offers good diversification with no correlation to Stocks in the long term
Gold can experience decade(s) long drawdowns
On its own, Gold is a volatile asset class ā in fact, if held for 5 years you could still have faced up to a 40% loss on several occasions over the past 3 decades
Not necessarily. Gold Price drivers are numerous. Gold is prone to short term sell-offs during a crisis at exactly the same time as Stocks ā this is due to market-wide liquidations. However, Gold reacts well within longer periods when Stocks under-perform and will hedge your portfolio against certain market risks
Gold Price is driven by 5 major factors: Opportunity Cost, Strength of USD, Macro Shocks, Very High Inflation and Commodity Demand
Gold price is more subtle than most investors think. Gold Price is driven by 5 major factors: Opportunity Cost, Strength of USD, Macro Shocks, Very High Inflation and Commodity Demand. It is a very risky asset on its own but works well within a portfolio
Dear Raphael, thanks for this excellent write-up, enjoyed it a lot!
Am working with goldminers on my side, usually the ETFs to diversify from single company risks.
Will bookmark your post for future reference.
It’s literally GOLD!
Cheers, Matt
Hi Matt – Following Warren Buffett š
Goldminers (and their ETFs) are like Gold on steroids. It’s a very capital intensive business and Miners’ profits will be very volatile.
Essentially it’s a leveraged bet on Gold so need to reduce your allocation vs. just holding a regular Gold ETF
Is that how you’re thinking about this, as well?
Raph
Dear Raph,
Correct, Iām able to hedge about the same notional exposure by only using about 1/3 of my capital. So, the asset allocation can get streamlined this way.
Thanks!
Matt
Makes sense
Looking forward to our coffee when things stablize a bit,
Raph
An excellent summary for someone considering the pros and cons of Gold within portfolio. There’s a lot of contradictory info out there and you don’t over-simplify it. Thank you
Appreciate the feedback Simon.
Raph
Would you recommend currency hedged ETCs? Or does that defeat the point given the additional costs and anyway high volatility of gold? You say that gold is anyway sensitive to the strength of the dollar, so even with hedging, one would anyway be exposed to a significant amount of currency risk? Thank you
Hi Simon –
Indeed, currency hedged ETCs have only marginal use. The point of holding Gold is to diversify into a hard currency, using a hedged product is equivalent to taking an additional FX bet – I am not sure this would be the intention in a typical portfolio.
Raph