From diversifying risk to acting as a haven asset, gold’s role in an investment portfolio is more versatile than that of any other asset. In this post we will discuss 8 reasons why you should invest in gold.
Content
Introduction
In another post, we discuss gold as a financial asset. We have analyzed against which assets gold competes and different options we have to invest in it.
Before getting into the reasons why you should invest part of your portfolio in gold, I would like to highlight something. Gold is an asset that can contribute a lot of positive things to your portfolio but putting all your money in gold would be like putting all your money in the stock market. The potential for returns would be good, but the risks would be too great and unnecessary.
For this reason, I it is probably a good idea to have 10-25% of our portfolio invested in gold. It is in combination with other assets when gold shines the most.
Why Invest in Gold
Let us now discuss 8 reasons why you should invest a portion of your portfolio in gold:
1) Diversification
Diversification consists of investing in assets whose returns are not highly correlated. The ideal situation is to invest in different assets that all have positive expected returns in the long term, but do not go up and down simultaneously.
Why don’t we want them to all move in the same direction? Because highly correlated assets would experience losses at the same time. And while it is very easy to say that we invest for the long run and markets always recover, managing our emotions can be tricky.
Plus, there is no guarantee that all markets will recover quickly. Just take a look at the Japanese Nikkei, the Eurostoxx 50, or many periods of the S&P 500, to realize that. Or even gold.
Profits are never guaranteed. Regardless of the assets we hold. However, combining different investments with positive expected returns, will significantly increase the probability that our portfolio will end up positive returns.
The good news is that very often gold and stocks perform different from each other. When one goes up, the other goes down, and vice versa. However, the gains of one tend to be larger that the losses of the other. In the table below are the annualized returns of the S&P 500, Japan’s Nikkei index, Germany’s DAX and gold:
2) Safe haven (insurance policy)
Beyond the benefits of diversification, gold is a great asset to own when financial and monetary crises take place. Gold is the safe haven asset par excellence. Hence, it like an insurance policy, because when all other assets in your portfolio fail, gold will save you.
That can have different meanings depending on the nature of the crisis. In a situation of economic and financial crisis, gold can become the best performing asset of your portfolio. In fact, we have experienced that before.
Gold was the best asset to own in the decade of the 1930s, during the Great Depression, and during the stagflation of the 1970s. It was also the best performing asset in the first decade of the 21st century after the massive crash in the Nasdaq and the bankruptcy of Lehman Brothers. The best asset in 3 decades out of the last 9. Not a bad record.
In times of monetary and political crisis, gold is what allows many citizens to save part of their wealth. Gold has allowed many millions of people throughout history to shield their savings, by not being exposed to heavy devaluations in fiat currencies. From the Germany of the 1930s, the United States of the 1970s, Russia of in the 1990s, and many emerging countries in recent years, including Argentina or Turkey.
3) Protecting the value of your savings against inflation
I am a bit reluctant to say gold is a good hedge against inflation. It certainly is in the long run. But that may not be true in the short or medium term.
Gold is not an asset that is going to rise 5% in price because inflation has been 5% in the most recent year. It is just not the way it works. However, if over a 10 year period prices go up an accumulated 50%, it is very likely that gold will increase in price by about 50% in the same period.
And therein lies the lure of gold. It can protect the value of our savings in the long term, so that we do not have to worry about monetary policy. In fact, the same gold that has value today is the one used in the Roman Empire 2000 years ago. It has not lost its value.
4) Real interest rates at historic lows
This point is very interesting. We all know that gold is an asset that produces nothing. It is just metal, so its yield is 0%. However, we also know that it protects the value of our savings and can perform greatly in terms of economic stress or monetary turmoil.
When it comes to savings vehicles, the biggest competitors to gold are cash and bonds. Both cash and bonds may pay us some interest. And that is something gold does not do.
However, the important thing is not to focus on the nominal interest received, but the difference between the interest rate and inflation. That is known as the real rate of interest.
Some people may argue gold is a bad investment because it lost 60% of its value between 1980 and 2000. What these people fail to appreciate is that we are talking about the two decades in history with the highest real interest rates in the world. Why would we want to have so much gold in 1990 if US Treasury or German government bonds pay us 8 or 10% annual interest with inflation at only 4%?
However, the situation is much different today. Though interest rates seem to be back, they are still significantly below inflation levels. Getting paid 2-4% interest in most major currencies while inflation still runs at 6-10% is not an attractive proposition.
In a world with so much debt, it is impossible for real interest rates to become positive again and stay there. Consequently, gold will probably be the better option in the next few decades.
5) Flawed monetary system
If we analyze why real interest rates are so negative, we will realize it is because there is no alternative if we want to avoid the bankruptcy of the system. The reality is that governments, businesses and families have more debt nowadays than any other time in history. And debt levels continue to go up.
There is no doubt we are nearing the end of the current monetary system, which began in 1971 when Richard Nixon took the United States out of the gold standard. Since then, the value of money has not been tied to gold anywhere in the world.
The last half a century has allowed governments and bureaucrats to print money as if it was going out of style, creating massive levels of debt and a societal issue in the form of inequeality.
We do not know how many years the current system has left, but we do know changes are coming relatively soon. China, Russia, and many other countries have been accumulating gold for many years. And it should not surprise us. Every time there has been a currency crisis, the world has come out of it with a new monetary system with gold at its core.
6) Geopolitical tensions
The world of the 2020s is likely to see the emergence of antagonizing geopolitical blocks, creating as much tension as the world has not seen since the 1960s and 1970s. Although hot war is unlikely between the superpowers, the rivalry between the Western block on one hand, and China and Russia on the other, will create geopolitical crises.
As a result, more and more countries may want to trade internationally in currencies that are not controlled by any one country. This means the global role of the US Dollar getting weaker.
And because of that, gold may return to one of its original roles, i.e. serving as an honest means of payment to settle trade between countries.
7) A glimpse into history
The investment industry, which predominantly only focuses on stocks and bonds, is heavily influenced by the returns seen over the past 40 years. It has been a time of falling inflation and interest rates, which have led to one of the largest rallies in stocks, bonds and real estate in history.
Interest rates reached 22% in the United States in 1981. And they have been going down ever since. Something similar can be said of Europe and Japan. It is very unlikely for this downtrend to continue, which means future returns are likely o be a lot different.
A look at financial market performance before 1980 will make crystal clear why gold has always ended up prevailing. We have seen political turmoil in some of the most important countries in the world, price controls, shortages, and a myriad of other things. The one asset that has always survived is gold.
8) Potential for large returns
To conclude, we had to talk about making huge gains. Many investors do not like to say they invest in gold to enjoy large returns. After all, the arguments discussed so far have to do with savings, protecting our wealth and buying an insurance policy.
However, since the macroeconomic scenario is so favorable to gold, we can also use it to seek gains. I believe we may see dramatic increases in the price of gold over the next few years. That does not mean it has to happen tomorrow or next year. Nonetheless, the setup is extremely bullish.
Something similar can be said about other assets that can act as hedges. The best example would be silver. And perhaps even Bitcoin.
To put it into perspective what happened in the 1970s, gold went from $35 to $850 between 1971 and 1980. This is a 24-fold increase. For its part, the price of silver went up 40 times. It may not happen again. But the potential clearly exists.
Conclusion
As I always try to say, do not just believe what I say. Question everything and make your own judgements. Learn as much as possible so you can make the best decisions for yourself. This is the only way you can have true control of your finances.
I am very bullish on gold. Though I am also a big believer in diversification. And these two beliefs are compatible.
If you would like to learn more about how you can build a very diversified portfolio, check out the following post:
The Winning Investment Portfolio
And if you would like to subscribe to my newsletter, you can do so here:
Clear Finances
Comments are closed.