Anyone old enough to remember the quaint pre-Internet days of summer fairs will remember the infuriating classic midway game of Whac-a-Mole, where participants, armed with an oversized sledgehammer, bang each furry animal that appears through a little hole only to have another pop up from another hole virtually instantaneously.
Lately, I’ve been feeling that the proponents of holding gold as an investment treat it as one big game of Whac-a-Mole, with investors being the hapless contestants. It seems gold bugs have an explanation for every movement in gold that relates in some way to world events, large or small.
As Mark Gimein of Bloomberg pointed out in a recent article on the subject, “When gold is going up, any explanation will do to explain the advance: a world economy in crisis, central banks printing money. And when it goes down, suddenly a slowing in China explains the drop.”
Before determining whether to include gold in a portfolio, it is best to first identify the role that it is supposed to play. Three basic themes are put forward by those in favour of inclusion.
First, gold is a hedge against inflation. Second, gold is a hedge against a precipitous fall in the equity markets and the end of the world. And, third, gold is a good investment because, for whatever reason, it generally goes up in value.
I’ll leave the third theme — gold is a good long-term bet — alone for the time being because it frankly doesn’t deserve analysis except to say that it is outright foolishness.
The first theme — gold as an inflation hedge — makes good sense since gold, generally accepted as currency and in limited supply (unlike fiat currencies), should maintain its buying power as prices shift.
However, even a cursory analysis of gold prices over the past 50 years compared to either interest rates or the consumer price index (available here for U.S. results) shows there are protracted periods of time during which gold has not appreciated in lockstep with inflation — like an insurance policy that pays off sometimes, but not all the time.
Most notably, any correlation gold had with inflation has all but evaporated over the past 10 years, with the two now seemingly totally unconnected. For those who believe interest rates will significantly rise and hyper-inflation is on the horizon, a much more direct way to buy insurance against (or simply profit from) this scenario is to invest in securities specifically linked to sovereign bonds (such as TIPS or inverse T-bill exchange-traded funds in the U.S.).
Now to the third theme: gold as insurance against the sky falling. Some people articulate this idea as wanting to have gold (along with canned food, oil, guns and plenty of ammunition) at the End of Days. Others, who live in the real world, speak more about gold as a hedge against a crash in the equity markets, which I’ll admit is the first step on the road to the end of the world, but it’s a very long road.
If only this were true. Alas, once again, when we need gold the most, it has let us down time and time again. Looking at three months in recent memory — October 2008, September 2011 and April 2013 — we see that owning gold doesn’t soften the blow of plummeting markets, and it has actually made it significantly worse.
In October 2008, during the heart of the financial crisis, the TSX dropped a whopping 16.7%. Gold dropped 20.3%. In September 2011, during the fiscal cliff debacle in the U.S. that saw Moody’s downgrade U.S. government debt, the TSX dropped 8.7%. Gold declined 11.1%. And last month, when the markets started to pull back following a bullish start to the year, the TSX was down 1.7%. Gold dropped 7.7%.
While I’m sure there is a pro-gold explanation for all of these events, the simple fact is that in virtually every test in recent memory, gold has failed as an insurance policy against equity declines.
Wanting something to be true doesn’t make it so. The simple truth is that, other than a purely speculative tool — one, which I must admit, has paid off brilliantly over much of the past 30 years — gold’s place in a portfolio is difficult to defend.