Enrich Your Future 19: The Gold Illusion: Why Investing in Gold May Not Be Safe

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 19: Is Gold a Safe Haven Asset?LEARNING: Do not allocate more than 5% of gold to your portfolio. “I don’t have a problem with people allocating a very small amount of gold to their portfolio, but they should only do it if they’re prepared to earn lousy returns most of the time.”Larry Swedroe In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 19: Is Gold a Safe Haven Asset?Chapter 19: Is Gold a Safe Haven Asset?In this chapter, Larry explains why you should not buy gold because you think it’s a good inflation hedge. While he is fine with people allocating a minimal amount of gold to their portfolio, Larry cautions that they should only do it if they’re prepared to earn lousy returns most of the time.Gold as an investment assetGold has long been used as a store of value, a unit of exchange, and as jewelry. More recently, many investors have come to believe that gold should be considered an investment asset, playing a potential role in the asset allocation decision by providing a hedge against currency risk, a hedge against inflation, and a haven of safety during severe economic recessions. Larry reviews various research findings to determine if the evidence supports those beliefs.The evidenceIn their June 2012 study, “The Golden Dilemma,” Claude Erb and Campbell Harvey found that in terms of being a currency hedge, changes in the real price of gold were largely independent of the change in currency values—gold is not a good hedge against currency risk.This means that the value of gold does not necessarily increase or decrease in response to changes in currency values, making it a less effective hedge than commonly believed.Erb and Harvey also found gold isn’t quite the safe haven many investors think it is, as 17% of monthly stock returns fell into the category where gold dropped while stocks posted negative returns. If gold acted as a true safe haven, we would expect very few, if any, such observations. Still, 83% of the time, on the right side isn’t a bad record.Gold is not an inflation hedge, no matter the trading horizonThe following example provides the answer regarding gold’s value as an inflation hedge. On January 21, 1980, the price of gold reached a then-record high of US$850. On March 19, 2002, gold traded at US$293, well below its price two decades earlier. The inflation rate for the period from 1980 through 2001 was 3.9%.Thus, gold’s loss in real purchasing power, which refers to the amount of goods or services that can be purchased with a unit of gold, was about 85%. This means that the value of gold, in terms of what it can buy, decreased significantly over this period. Gold cannot be considered an inflation hedge over most investors’ horizons when it lost 85% in real terms over 22 years.Gold is not as attractive an asset as many may thinkInvestors are often attracted to gold because they believe it provides hedging benefits—hedging inflation, hedging currency risk, and acting as a haven of safety in bad times. The evidence demonstrates that investors should be wary.While gold might protect against inflation in the long run, 10 or 20 years is not the long run; you need a longer investment horizon to make actual returns. And there is no evidence that gold acts as a hedge against currency risk.As to being a safe haven, gold is a volatile investment capable and likely to overshoot or undershoot any notion of fair value. Evidence of gold’s short-term volatility is that over the 17 years (2006-2022), the annual standard deviation of the iShares Gold Trust ETF (IAU), at 17.2%, was higher than the 15.6% annual standard deviation of Vanguard’s 500 Index Investor Fund (VFINX).In addition, gold experienced a maximum drawdown of almost 43%—safe havens don’t experience losses of that magnitude.Don’t allocate more than 5% gold in your portfolioWith this evidence in mind, Larry advises investors never to own more than 5% of gold in their portfolio. Further, investors should remember that gold only acts as a safe haven on occasion, but there are also many times when it doesn’t. Historically, the probability is close to a 50/50 coin toss, slightly favoring gold.Alternative assets to own instead of goldLarry says investors are better off owning real assets than gold because they have expected actual returns. So, for example, real estate prices over the long term go up because part of the cost is land and buildings, making real estate an excellent long-term hedge.Another asset Larry suggests instead of gold is infrastructure ETFs that, for example, own toll roads and water facilities. Such assets raise their prices with the inflation rate and can act as a hedge.Further readingClaude Erb and Campbell Harvey, “The Golden Dilemma,” Financial Analysts Journal (July/August 2013).Claude Erb and Campbell Harvey, “The Golden Constant,” May 2019.Goldman Sachs, “Over the Horizon,” 2013 Investment Outlook.Pim van Vliet and Harald Lohre, “The Golden Rule of Investing,” Jun 2023.Did you miss out on the previous chapters? Check them out:Part I: How Markets Work: How Security Prices are Determined and Why It’s So Difficult to OutperformEnrich Your Future 01: The Determinants of the Risk and Return of Stocks and BondsEnrich Your Future 02: How Markets Set PricesEnrich Your Future 03: Persistence of Performance: Athletes Versus Investment ManagersEnrich Your Future 04: Why Is Persistent Outperformance So Hard to Find?Enrich Your Future 05: Great Companies Do Not Make High-Return InvestmentsEnrich Your Future 06: Market Efficiency and the Case of Pete RoseEnrich Your Future 07: The Value of Security AnalysisEnrich Your Future 08: High Economic Growth Doesn’t Always Mean High Stock Market ReturnEnrich Your Future 09: The Fed Model and the Money IllusionPart II: Strategic Portfolio DecisionsEnrich Your Future 10: You Won’t Beat the Market Even the Best Funds Don’tEnrich Your Future 11: Long-Term Outperformance Is Not Always...