It can hardly have escaped your notice: gold is hot! The gold price is currently breaking record after record, and even the ‘mainstream’ financial media can no longer ignore the yellow metal. But when I read these stories, they mostly raise a lot of questions for me. Are traditional investors really that naive now, or are they deliberately looking the other way?
Actually, gold is not ‘hot’ at all. Over the past two weeks, I have spoken to a dozen investors working at large asset managers in the Netherlands and abroad. When I ask them about their allocation to gold, the prevailing answer is: ‘we don’t invest in gold’, or even ‘investing in gold is a no-go’.
Moreover, the reasons given for not investing in gold are not particularly convincing. Arguments such as ‘gold has no cash flow’, ‘gold is too volatile’ and ‘our clients don’t ask for it’ are common motivations.
Trinity
As for the core characteristics - return, risk and diversification - that usually determine whether something is an interesting asset class, I hear little. Probably because gold, especially with the last few years factored in, scores well in all three areas.
The gold price has risen some 45 percent since last October, leaving most stock markets behind. While this is dismissed by many investors as a short-term rally, that rise does ensure that gold, net of cash flows, has beaten bonds over the last 50(!) years.
On top of that, gold’s volatility has decreased significantly compared to bonds, or better the risk of bonds has actually increased. The result: gold’s Sharpe ratio over the same fifty years is now comparable to that of bonds, and even higher over more recent periods.
Bonds have also lost ground in terms of diversification. The correlation between equities and gold, and stocks and bonds, has been low but positive in recent years. That of bonds was even slightly higher and less stable. The assumed negative correlation has not been present for some time, and a long history shows that it is the exception rather than the rule.
Spread
This begs the question of why (traditional) investors do not ‘really’ spread by including at least some gold. When two asset classes provide diversification against equities, any ‘SAA specialist’ would recommend including all three in a portfolio.
So far, I have only focused on hard historical data, which many allocators are only too happy to hide behind. But if you dare to look a bit to the future as well, the absence of gold in portfolios is even more absurd. Now I have to be careful not to be dismissed as a ‘gold geek’, but there is a reasonably objective reasoning I can outline here.
For example, compare the total market value of gold with the global money supply and debt. Relative to every dollar in M2 money supply, there are less than 20 cents of gold. And relative to all the world’s debt, there are barely six. Once upon a time, we had the philosophy that underneath our debt or in the face of our money, there had to be something of value. Since the rise of central banks, that was gold in the vaults, giving confidence that our money was backed.
Confidence in system questioned
It seems obvious to me that when you print money and issue debt on a large scale, there are going to be questions about confidence in that system. And that’s quite apart from the countries or regimes that don’t want that ‘western’ money.
When you combine these thoughts with the objective rules on diversification and portfolio construction that are widely used to arrive at an SAA (Strategic Asset Allocation), you have to question the attitude of traditional investors towards gold.
Especially when you see that when someone comes up with a ‘great’ marketing story on private equity and debt - the very name of which reveals that these are the same asset classes that many a portfolio is already full of - investors don’t know how much money to allocate.
I fear that many of my questions will remain unanswered for the next few years.
Jeroen Blokland analyses eye-catching, topical charts on financial markets and macroeconomics in his newsletter The Market Routine. He is also a manager of the Blokland Smart Multi-Asset Fund, which includes 25 pe cent gold in its strategic asset allocation.