Don’t Be Drawn to Gold’s Recent Shine

Since hitting a low last August, a certain yellow metal is up 14.0%.^[i] Meanwhile, world and US stocks are down -1.8% and -1.3%, respectively.^[ii] Armed returns over this rather arbitrary timespan and fund inflows into gold ETFs, many argue gold’s long-reputed “hedge” against market volatility is drawing investors’ attention. This, plus low interest rates, are fuel for gold, they surmise, as the non-interest bearing asset has less to compete with. But in our view, a closer look suggests these claims are dubious. We think the case for gold as an investment, as ever, is weak. If you are thinking of adding some shine to your portfolio, we suggest thinking again.

Attributing mystical powers to gold’s role in your investments is as old as gold investing in America. Literally. Americans were legally barred from owning bullion for more than 40 years in the 20^th century, until President Gerald Ford legalized it in 1974.^[iii] A New York Times article that ran December 4, 1974—27 days before legalization took effect—summed up the myths:

Advocates of gold ownership point to the age-old allure of the precious metal and describe it as a monetary life preserver in a sea of rapidly eroding paper money and rampant inflation. … At the heart of the current debate is a mystique about gold that has persisted for centuries. Even if all else fails, if Governments tumble and economies sink into deep depression, the argument goes, gold maintains its basic value.^[iv]

That “intrinsic value” argument, we think, underpins many gold-as-a-hedge arguments. But in a market economy, value is only what someone is willing to pay for it—the going price.^[v] For gold to act as a hedge, its price must move counter to stocks’ with some regularity. During Q4’s stock market correction—a correction is a short, sentiment-driven drop of about -10% to -20%—gold did move counter to stocks, driving gold’s outperformance in 2018’s second half. But in the 12 global equity market corrections since 1980, gold has declined 7 times.^[vi] Its average return during a correction? -3.3%.^[vii] While that may not be awful, it doesn’t seem like a wonderful hedge.

Similarly, world stocks have declined in 11 calendar years since 1975. Gold rose in five and fell in six.^[viii] Those six failed hedge years include 1981, when world stocks declined a mere -4.8% versus gold’s massive -32.1% drop.^[ix] They also include 2015, when world stocks fell just -0.9% while gold fell -12.1%.^[x] We don’t suggest taking gold’s successful Q4 2018 hedge to the bank.

As for the notion low interest rates favor gold, a question: Conventional wisdom (which is also sketchy) argues gold hedges against inflation. Yet hot inflation usually brings high interest rates.  Which common (and faulty) bullish gold narrative are we supposed to believe?

Anyway, we can at least test and put to bed the notion low rates are bullish for gold. We have good 10-year Treasury and 3-month Treasury rate data from 1920 to the present. The median rates since 1920 were 4.0% and 3.1%, for 10-year and 3-month debt, respectively, over this span.^[xi] We took these median figures and reduced them by 1 percentage point each to approximate a “low rate” environment—and vice versa. Using these definitions, we found forward 12-month gold returns during low-rate periods to be lackluster—averaging 0.1% and -7.1% during low 10-year and 3-month rate periods, respectively. If we define high and low rate periods differently, using the average since 1975 to match gold’s legality, low rate periods look better but do not consistently top high. That said, we think this timeframe is less telling about rates, overemphasizing the high-rate 1970s and early 1980s.

Ultimately, gold is a dodgy long-term investment with lower returns than stocks and higher volatility. The mythology might dress up gold as a permanent winner, but about the only way to win in gold is to have stellar market timing—like the ability to nail that sentiment-driven upswing in Q4 2018. But if you can do that, you have far more lucrative options than gold anyway.