March 31, 2011: A Rational Look at Gold

Many investors have a strong negative reaction when they read that 25% of my asset allocation is in gold. I feel that many hold a deep misunderstanding of gold, as if it is an asset class only for the overly paranoid. It's as if gold is not for “serious long-term investors." After all, it's just a bunch of shiny yellow bricks with no cash flow!

If gold is such a lousy asset class, why do governments and central banks around the world hold gold? Are they all paranoid gold bugs? I'm not convinced.

The real truth is that over the long run gold has a remarkable history of preserving purchasing power. This gives it a special role in any portfolio because in a world of fiat money, purchasing power is constantly being eroded. Even global currency diversification is not a worthy substitute for gold, because it is possible for all fiat currencies to be declining at the same time. In fact, in our globalized economy central banks actions are becoming more correlated with each other, leaving few options for inflation protection.

I want to be very clear that I use gold as tool that is part of a broader asset allocation. It is not an amazing investment in isolation. However, it's ability to preserve purchasing power cannot be ignored and it's violent price movements, with low correlation to other asset classes, gives it a unique role with no substitutes.

Is gold in a bubble?
I have no idea.

Is gold dramatically undervalued?
Again, I don't know.

Will it protect my stocks, bonds, and cash from monetary inflation?
Yes.

Will it provide violent price movements with low correlation to other asset classes?
Yes.

Will it lower the volatility and risk of my portfolio and increase my portfolios Sharpe ratio?
Yes.

Ultimately, that's what really matters to me.

1 comment:

  1. Great explanation. I like how honest you are about the uncertainties of the market.

    ReplyDelete