Gold has been used as a hedge against higher inflation for centuries, most notably during the double-digit inflation during the early 1980’s. Let’s talk about what we mean when we say, “hedge”. It’s an important word but one that can be used to mean different things in different situations.
For a long-term investor seeking to hold a balanced portfolio, it’s important to construct a portfolio that can withstand all sorts of market environments – up, down, or flat, volatile or calm. Gold can play a valuable role in this regard, as gold has a very low correlation to stocks. Over the past 45 years, the average correlation of stocks (as measured by the S&P 500) and gold is below 15%. (Correlations are measured in a range where a maximum correlation of 100% being a 1-for-1 tracking of the performance of two items, and a 0% correlation would be that the two always move in precisely opposite directions.)
Sometimes, gold and stocks both rise together, such as in the back half of 2020. Other times, like during the Great Recession in 2008, stocks fall while gold rises.
The good part is that both gold and stocks have delivered strong returns over long timeframes. Here’s a performance chart of both stocks and gold for the past 30 years:
How We Invest in Gold
For our client portfolios, we have been buying small allocations in two of the most established gold ETFs, the iShares Gold Trust (ticker IAU), and the SPDR Gold Shares Trust (ticker GLD). Both hold physical gold bullion as their only asset, and seek to track the real-time price of gold as closely as possible. Both ETFs have expense ratios less than 0.4%, and have tracked the price of gold to within 0.1% in both up and down markets.
We feel these allocations to gold are prudent at this time for its diversification benefits, and for gold’s ability to act as a hedge against inflation – and for what typically arrives with inflation, a falling U.S. dollar. With inflation rising fast, and the U.S. dollar facing headwinds from continued stimulus measures and fiscal spending, we feel that an allocation to gold provides a unique hedge. And gold has many legitimate end markets that are seeing stimulated demand right now, beyond just the jewelry and cosmetic uses one first thinks of. Gold is used in numerous industrial and medical industries, and gold has a finite supply, further bolstering a long-term case for the price of gold rising.
It’s important to note that as a store of value, gold has stood the test of time – and we mean a long, long time. We can go back 2,000 years to how much Roman soldiers were paid in gold, and find that their salaries were pretty comparable to what military personnel are paid today. Imagine retaining such purchasing power after 2000 years! That is the uniqueness of gold.
Gold has lagged the market so far in 2021, as the U.S. dollar has remained strong and so have stocks. Gold has in a sense been losing out to “more interesting options,” but we feel that is a temporary scorecard based on oddities such as cryptocurrency.
A Note on Cryptocurrency
We’d like to make brief mention of cryptocurrency and its relationship with gold as a “anti-dollar” bet. People who are very bullish on cryptocurrencies like Bitcoin (BTC) believe that cryptocurrency will one day replace the U.S. dollar, and for that matter, all “fiat” currencies. They also believe in its decentralized nature in that it strips out the need for intermediaries like banks to handle transactions.
In questioning the long-lasting potential of bitcoin, we’d first point out that it only has a 10-year track record, and its one that is littered with roller-coaster volatility. There’s simply too much to be proven, as time is the most pure vetting machine that exists. Real currencies or “stores of value” shouldn’t drop 20% in a day, as crypto has done multiple times in just the past year (and week).
Many corners (and some back alleys) of financial markets are in a strangely amped-up greed cycle. Crypto has treated some early investors well but faces massive liquidity issues, legal issues, and most importantly, spending issues. It doesn’t function as a real currency, merely as a speculative vehicle. But, at the moment bitcoin is likely attracting some capital away from safer investments like gold.
The key difference for us is that bitcoin would represent a speculative investment whereas gold represents a portfolio diversifier backed by a thousands year track record.