I get asked this question after two specific things happen:
- A recent period of out-performance by either gold bullion or gold mining shares, which plays into the greed factor.
- Or during periods of heightened political or economic uncertainty, which plays into the common fear factor.
First, let me address item #1.
The potential return on gold, commodities and collectibles like art, is totally based on the “greater fool theory.” By that I mean, you buy it today at a certain price and “hope” to sell it to someone else at a higher price sometime down the road. In the meantime, gold, commodities or art, are not doing anything. They don’t earn anything, pay any dividends or cash flow. In fact, it costs money because you have to pay someone to store gold for you or in the case of art you have to store it or insure it.
Many people are surprised to learn how poor the historical investment returns have been with gold. The article, “Is Gold Worth its Weight in a Portfolio” goes into much more detail on the historical returns of gold. The conclusion paints an interesting story:
… from a long-term perspective, gold has not experienced a reliable or sustained rise in value. In fact, its price appreciation has been limited to unpredictable, isolated episodes of high demand. Investors who attempted to time these episodes exposed their wealth to potentially higher risk and to the opportunity cost of missing out on stock market growth.
Now, let’s address item #2.
If I break down the rationale for holding gold during periods of heightened political or economic uncertainty; the question people are asking is whether gold would protect their wealth or provide some sort of “safe haven” against inflation or very weak financial markets.
Unfortunately, it is these claims that many investors most commonly fall prey to – the rambling of the conspiracy theorists and the marketing hype.
If we look beyond the hype, in some periods gold has vastly out-performed inflation, but in others it hasn’t. The risk is that gold has provided these unreliable returns with substantially higher volatility than inflation. Since 1970, gold has been 15 times more volatile than the Consumer Price Index, which hardly makes it a good inflation hedge.
As a portfolio diversifier, the benefit of gold is vastly overrated as well. Gold and commodities have a 0% expected return, as price appreciation is no certainty. Proper portfolio construction should only include asset classes that have positive expected returns.
For my clients portfolios I have never had a special allocation to gold or commodities. However, if gold mining shares happen to represent 10% to 15% of a certain stock market like Canada, then we would have a similar type of allocation. Any significantly higher allocation is really speculating.
I am sure the gold bugs and conspiracy theorists will vehemently disagree with the points above. However, I have yet to see any credible evidence or data to the contrary.
Additional Articles of interest related to this subject: