Gold! It’s up 18.8% in 2016 to date—an upward burst after years of deep decline.i But lately, it may be more apropos to type, “Gold?” You see, that 18.8% return was 28.9% at the shiny yellow metal’s year-to-date high on July 6.ii The big returns combined with a recent, sharp sell-off seem to have many wondering: Is this a blip, and will gold soon resume its trajectory after the September 2011to December 2015 bear market, when gold prices fell 44.3%?iii Or was this year’s rise a false rally? Sorry to disappoint, but we won’t hazard a guess. To us, gold’s movements are mostly trivial—and we think they should be for you, too. We don’t believe gold should have a material allocation in most investors’ portfolios—the frequently cited rationales for owning gold simply don’t stand up to a fact check.
Some investors think gold is a “safe haven”—a refuge from stock-market volatility. But history suggests otherwise. To be a viable safe haven, gold should be either negatively correlated to stocks on a relatively consistent basis—usually rising when stocks fall, and vice-versa—or it should be less volatile than stocks. Neither condition is true of gold.
We measured the correlation coefficient between the monthly returns of gold and the MSCI World Index since November 1973—when the US government began allowing gold to trade freely, establishing a fully global gold market. A correlation coefficient statistically measures the extent to which two series of numbers are related—a coefficient of 1 means the two move in lockstep; -1 means they are exact opposites. The correlation coefficient between global stocks and gold is 0.1. They have next to no relationship, so there is little historical evidence gold performs well when stocks fall, and vice versa.
As further illustration, consider Exhibit 1. We shaded historical equity bear markets since 1975 and plotted gold’s movements. There is no consistent direction here. Gold crashed alongside stocks in the early-1980s equity bear. It rose a bit in 1987 and 1990. Gold fell during the first year after the Tech bubble burst in 2000. In 2008, gold investors went on a wild ride sandwiching positive results around a roughly -30% drop.
Exhibit 1: Gold in Equity Bear Markets
Source: FactSet, as of 10/11/2016. 12/31/1975 to 10/10/2016.
As for the other possible “safe haven” trait—low volatility compared to stocks—gold fails the test, too. Gold has a higher standard deviation than stocks.iv That means its returns deviate from their long-run average more than stocks. Now, in theory, a more-volatile asset should compensate you with higher returns. Yet stocks’ annualized returns far exceed those of gold. The MSCI World Index has annualized returns of 9.0% since November 1973.v Gold? 6.2%.vi It also posts positive returns far less often than global equities. If this is a stable asset, a safe haven, why does its price fall more often than stocks’ over any meaningful time period? Why is it more volatile? None of this looks like a very effective haven.
Exhibit 2: Gold and Global Stocks’ Historical Frequency of Positive Returns
Source: FactSet, as of 10/11/2016. 12/31/1975 to 10/10/2016.
Many claim gold isn’t so much a safe haven against volatility as it is a way to hedge against rising prices. Rising inflation presumably makes your paper money worth less, so maybe you’d prefer something global central banks can’t dilute by increasing the money supply. (Never mind that gold miners can dilute your gold by increasing the gold supply.) This theory may sound perfectly logical—and it may have been true at one historical point. But it hasn’t been close to correct in recent decades.
Since November 1973, the median inflation rate in the US is 3.2%.vii (This is based on US CPI, as gold is denominated in US dollars, so it seems like the most apples-to-apples comparison.) Since 2000, the US has seen overall low inflation and high gold returns. What gives? Moreover, as Exhibit 3 shows, gold’s median forward 12-month return is higher in periods when inflation is below 3.2%—and this is especially true when inflation is far below—than when it is above.
Exhibit 3: Ineffective Against Inflation, Part 1
Source: FactSet, as of 10/12/2016. Gold forward 12-month return and US Consumer Price Index year-over-year percentage change.
Now, before you think low inflation is uber-bullish for gold, consider: From 2012 to 2015, inflation was very low and gold fell. It’s still low now and gold is up. It just seems there isn’t any connection here to speak of.
What’s more, even the returns in higher-inflation periods are skewed, as shown by the returns from 1973 to 1979, a very inflationary period just after gold became freely traded again. Exhibit 4 illustrates these results differently, showing the US Consumer Price Index and gold indexed to 100 at December 1979. As you can see, gold failed to keep pace with inflation over the ensuing 35-plus years. To us, this is not the stuff of an effective inflation hedge.
Exhibit 4: Ineffective Against Inflation, Part 2
Source: FactSet and the Federal Reserve Bank of St. Louis, as of 10/12/2016. Gold and the US Consumer Price Index, both indexed to 100 at 12/31/1979. 12/31/1979 to 08/31/2016.
Gold has lower returns than stocks with more volatility. It doesn’t shield you from inflation or equity-market negativity. So if gold isn’t any of these rumored things, what is it?
Fact: Gold is just a commodity—nothing more, nothing less. It is like silver, titanium, lead, platinum, aluminum, copper or zinc.viii There are no magic properties, no specific amount of gold allocation from an investing standpoint. Rather than ask what allocation of gold to have in your portfolio or where gold is heading from here, we believe you’d be better off asking why you should own gold in your portfolio in the first place.
i Source: FactSet, as of 10/11/2016. Gold price, percent change, 12/31/2015 to 10/10/2016.
ii Source: FactSet, as of 10/11/2016. Gold price, percent change, 09/27/2016 to 10/10/2016.
iii Source: FactSet, as of 10/11/2016. Gold price, percent change, 09/6/2011 to 10/10/2016.
iv Source: FactSet, as of 10/11/2016. Standard deviation of gold monthly and annual returns and MSCI World Index monthly and annual returns, November 1973 to September 2016.
v Source: FactSet, as of 10/11/2016. Annualized MSCI World Index return with net dividends, November 1973 to September 2016.
viIbid. Annualized gold price return, November 1973 to September 2016.
viiSource: FactSet, as of 10/12/2016. Average of year-over-year US CPI percentage change, November 1973 to August 2016.
viii A hat tip to the very unscientific panel of 35 colleagues polled, who were asked “What metal is the opposite of gold?”