Thoughts on Gold

A few weeks ago, I attempted to listen to Tim Ferriss interview Peter Mallouk, president of one of the largest independent wealth management firms in the country. If you don’t know Ferriss, he is famous for his best-selling book, The 4-Hour Work Week. Mallouk runs Creative Planning, one of the fastest growing RIA firms managing more than $35 billion in client assets. I was exited to hear the almost two-hour conversation between these two. That is until I heard the first question.

So, what are your thoughts on gold?

Seriously?! I know Ferriss is not in the advisory business, but of all the questions I might ask Peter Mallouk, gold would not be on that list. I thought we stopped talking about gold when Mr. T made an appearance on Bloomberg and talk radio became saturated with commercials urging us to buy gold in IRAs. But apparently gold remains a popular subject among investors, so I decided to revisit my thoughts on gold.

Gold is a soft, malleable metal. Technically it is an element, symbol Au. The two largest uses for gold are jewelry and direct physical investment. It was used to make early currency and backed most of the first paper currencies. There are references to gold in religious texts, such as the Bible. Humans have valued gold for as long as recorded history. We wear it around our fingers to symbolize marriage, arguably one of life’s most important decisions.

A U.S. dollar could be exchanged for gold until President Nixon ended the “gold standard” in 1971. Today, no major currency in the world is backed by gold. But our association of gold with money continues. Central banks own and store vast sums of gold in vaults around the world. I have toured the Federal Reserve Bank of New York, where you can ride an elevator down to the bedrock of Manhattan to view the gold storage vault, behind bars of course.

Last week, the Bank of England refused a request from Venezuela’s proclaimed President, Nicolas Maduro, to withdraw $1.2 billion in gold reserves. Maduro is wildly unpopular in Venezuela, where the average resident lost 24 pounds last year from lack of food, and is thought to have rigged the last election in his favor. Without a doubt, gold has significance on a geopolitical scale.

But what about gold as an investment?

Gold pays no dividends or interest. There are no expected revenues or cash flows from gold. The only way to value gold is to measure its supply and demand. This makes gold a commodity. Some say gold is a hedge against inflation. It is not. The volatility of gold is higher than that of stocks, making it an imperfect hedging tool, even if there were a correlation between gold and inflation. Treasury inflation-protected bonds, on the other hand, are built to be an exact hedge against inflation.

Many remark, “Gold has never been worth zero.” While true, how is this a case for making an investment? The price could decline 50%, 70%, 90% from purchase price. Is it comforting to make this statement about a stock that lost 90% of its value? “Never been worth nothing.” Whew. What a relief.

Others claim gold is a good asset to hold when investors panic, claiming that when people panic, they buy gold. There is some evidence of this behavior, specifically during the Great Financial Crisis, but not in every bear market. I see no benefit to owning gold that cannot be accomplished by investing in a diversified portfolio of stocks and bonds tailored to match your risk tolerance.

Some keep gold coins in their safe or safety deposit box. They are waiting for an apocalyptic societal breakdown event when paper money becomes worthless. I am not sure who will take their gold coins if this happens. Plus, gold is heavy. You cannot carry $1 million worth of gold if you hope to maintain your wealth on the run. For this scenario, I recommend diamonds.

The one case I can justify for gold is as a diversifier in a portfolio. The price of gold moves differently than stocks and bonds. But even in this case, it makes sense to own a basket a commodities, and not gold alone.

Warren Buffett put it best;

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.




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