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November 2017

All that glistens…

Gold has always held a certain appeal for humans. Its lustre, due to a lack of oxidation, makes it pleasing to look at and to handle.  Yet, it is simply a lump of metal that generates no income and will only be worth what someone else wants to pay for it at any point in time.  Given the lack of cash flow, common valuation models are not useful. Warren Buffett is not a big fan:

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Gold has suffered prolonged, negative real returns over periods as long as 20 years and delivered an annualised return of just 1.5% p.a. after inflation – around 5% lower than equities – between 1987 and 2017, yet with comparable volatility.  In its favour, gold prices are uncorrelated to equity markets.  Yet many investors seem enamoured by its fabled investment properties.  Do these claims tack up?

Claim 1: gold is a good defensive asset at times of global equity market crisis

In the period under review, there were three substantial equity market crashes.

Figure 1: Gold as a defensive asset from 1/1979 to 6/2017

Peak date Global Equity Fall Trough date Gold Short-dated bonds
Jan-00 -48% Jan-03 18% 17%
Nov-07 -41% Feb-09 90% 12%
Oct-87 -29% Nov-87 -7% 2.5%

Data source: MSCI World Index (net div.), Citi WGBI (1-5) hedged GBP from Morningstar © All rights reserved.

The spectacular return of gold during the credit crisis was perhaps driven by fear, pushing up the price of gold.  If you are able to guess how others are going to behave in the future, you would be able to take advantage of gold’s hedge against fear, buying and selling it at appropriate times.  Market timing is exceptionally hard to do, without the luxury of hindsight.  Holding gold as a strategic diversifier in a portfolio carries with it a punitive, long-run zero real return assumption. Gold may be a good hedge against fear, but it is hard to exploit in practice.

Claim 2: gold is a good inflation hedge

Perhaps one of the most quoted properties of gold is its supposed ability to provide a hedge against inflation.  The evidence does not support the assertion, at least over normal investment horizons.  Over the long-term gold keeps up with inflation; A US army private gets paid almost the same – in terms of gold – as a Roman legionary did 2,000 years ago!

The belief that gold is a good inflation hedge is anchored on its performance during the late 1970s when gold prices and high inflation rose in tandem.  James Montier of GMO undertook an analysis that demonstrated the 10-year inflation for each decade and the gold price return were uncorrelated except for the 1970s[1].   In terms of an inflation hedge, stocks and index-linked gilts provide better opportunities to achieve this objective.



Figure 2: The real price of gold and underlying annual inflation 1/1979 to 6/2017

Data source:  UK Retail Price Index – Bank of England

Claim 3: gold is useful store of wealth in an Armageddon scenario

A case can perhaps be made for holding some physical gold in the form of coins or ingots, in the liquidity reserves of those who fear the breakdown of fiat (paper) currencies at times of extreme market events, such as those surrounding the collapse of Lehman Brothers or even greater global calamity such as another world war.   In the extreme collapse of the financial system, paper gold (e.g. via a gold fund or ETF) would be less favourable given the risk of counterparty failure and the potential inability to access the underlying gold when it is truly needed.  Don’t forget that gold is very heavy and if you bury it, you need to be able to find it again; our museums are full of gold Roman coins, buried and lost two thousand years ago!


Enjoy your gold jewellery, perhaps hide a few Krugerands in the airing cupboard, but don’t believe that owning gold will improve the structure of your portfolio.  From an investment perspective, all that glistens is not gold. 


Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

[1]      Montier, J., (2013) No Silver Bullets in Investing (just old snake oil in new bottles), GMO White Paper, December 2013