This is a guest post by Kim Iskyan, the founder of Truewealth Publishing. We had interviewed Kim previously where he shared insights about succeeding as a retail investor. Today he shares about Gold and why retail investors should have it in their portfolio.
A lot of investors either love gold… or hate it. But there’s very good reason to move past your emotions – and invest in gold regardless of your feelings about it.
There are the “gold bugs” – people who think that the financial world is on the brink of collapse and the only asset that will survive is gold. They point out that gold is immune to inflation, it’s historically been used as a global currency, and it is not affected by what governments do with the economy. In a world of negative interest rates, that gold doesn’t pay dividends doesn’t matter. So, they stock up on gold and wait for the apocalypse.
Then there are the investors who point out that gold is a terrible long-term investment. It has done very well so far this year – it’s up 19% year-to-date – because the US dollar has been weakening (we’ll explain this relationship later.) But over the long term, gold performs worse than most stock markets and other assets… and even owning bonds for the past 30 years would have earned you better returns. You don’t earn interest for holding gold. Even more, gold is an asset that you have to pay to own – either for storage costs or to buy a good safe.
Like famous investor Warren Buffett said about gold, “It 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.”
Long-Term Price Returns (in USD) through December 2015
But no matter which camp you are in, you should have some gold in your portfolio.
There are three good reasons why.
1. Gold protects your portfolio when stock markets crash.
Stock markets and gold have little correlation. The table below shows the correlation of gold with various Asian markets.
30-year Market Correlations
As the table shows, stock markets tend to move in the same direction – which means that they’re positively correlated. The closer the number is to 1, the more correlated they are. For instance, the STI has a strong positive correlation with Malaysia’s KLCI, the S&P 500, Hong Kong’s Hang Seng index and Japan’s Nikkei. A positive correlation means that these markets they tend to move in the same direction at about the same time.
But all of these markets have a very low correlation with gold. If two markets have a correlation at or near zero, it means they move independently of each other. When a correlation is negative, two assets tend to move in opposite directions. A correlation of negative 1 means they are perfectly negatively correlated.
For example, over the past twenty years the STI has a correlation with gold of just 0.20. That means that if the STI falls, gold prices will likely do their own thing. There’s very little correlation between gold and any other market. And the STI’s correlation with gold is much lower than its correlation with any other stock market.
This means that gold can be a great hedge for your portfolio. It can give you some protection when stock markets fall. This year is a good example. The STI is down 4% so far this year, the S&P 500 is up less than 1%, the Hang Seng is down 7% and the KLCI is down 3%. But the price of gold is up 19%.
2. Gold protects you against the degradation of paper currency.
Across time and culture, gold has been a way to preserve value in a way that paper money can’t. That’s partly because (unlike paper money), the gold supply is fairly stable. Newly mined gold only adds about 1.7% to the global supply of gold each year.
During the past forty years, no country has used gold to back its currency. In 1971, the US was the last country to abandon the gold standard. All currencies are “fiat currencies,” which means that they’re worth something just because the issuing government says it is… and the people who use this legal tender place their collective faith in it.
That usually works. But when people lose faith in governments – as a result of bad politics, war, political instability, inflation or a combination of these – some investors look to gold to protect their wealth. So a rise in the price of gold versus a given currency may be a sign of trouble for the government backing that currency.
Since the 2008 financial crisis, governments around the world have printed more paper currency and undertaken other currency magic to try to support economic growth. During the six years following the start of the crisis, the amount of US dollars in circulation went up fivefold.
From the time the global financial crisis started, the price of gold soared. In 2008, an ounce of gold cost US$800. By late 2011, it was worth over US$1800 an ounce – a gain of over 125%.
But then, as the crisis faded and demand for the US dollar rose, the price of gold fell. So, when the world’s most important currency was struggling investors ran to gold. It was the best way to protect their money from a falling US dollar. (This is also a perfect example of negatively correlated assets.)
Gold generally holds its value when paper currencies are degraded… or when governments decide to print more of it. That’s because it is a global currency that has a tangible value.
3. Donald Trump’s economic strategy
Last week, US Republican presidential candidate Donald Trump implied that as the country’s president, he might try to “make a deal” with bond holders, to pay them back less than what the US government owes them.
This would undercut one of the foundations of finance. It would mean short-term US Treasuries (or, bonds) would no longer be viewed as “risk-free” investments. It would be catastrophic for the US economy, global finance and investors. (Trump later clarified his comments, saying that the US would never default on its debt because the US government can print money… which reinforces point 2 above.)
Implementing – or even just hinting at – such a policy would be disastrous for markets. But it would be good for gold. Gold has traditionally been viewed as a safe haven when there has been uncertainty in the world. If investors no longer feel comfortable with US Treasuries, gold prices will soar.
So, whether you are a gold bug or a gold sceptic, owning some gold in your portfolio makes sense. It is one of the best hedges against falling markets, falling currencies and politicians.
The SPDR Gold Shares ETF, (ticker: GLD on the New York Stock Exchange; code: O87 on the Singapore stock exchange; and 2840 on the Hong Kong Stock Exchange), is one of the easiest ways to get exposure to gold.