_{Originally published 09/11/2020}

Investing in gold is once again gaining in popularity, with the price appreciating over 25% for the year thus far. On August 6th the price reached an all time high of $2,065 an ounce and it has since retracted. Some investors view gold as a hedge against tail risk, inflationary environments, or the potential downfall of fiat currency. The belief among some of the gold diehards is that gold has been a store of value for thousands of years, and will continue to be going forward. Another belief is that since gold, in theory, has a fixed supply (See gold mining of asteroids), then it should maintain its value.

Before we take a look at how investing in gold may or may not benefit a portfolio, let’s look at a brief snippet of its history here in the United States.

The United States and Gold

Until 1974, the price of gold in the United States was largely fixed by the US Government and they only changed it 4 times since 1792.

August 15th was the 49 year anniversary of Richard Nixon removing the gold standard from the US Dollar. 38 years prior to Nixon doing so, FDR made it illegal for citizens to own gold. He ordered all gold coins, bullion, and certificates to be delivered to the Federal Reserve Bank by May 1st, 1933 for the set price of $20.67 per ounce. In 1934 after the Federal Reserve had collected much of the gold, they increased the price to $35 an ounce, allowing the Fed to inflate the money supply. Previously, the government had fixed the price of gold to $20.67 an ounce from 1834 – 1934.

The price of gold was fixed at $35 an ounce from 1934 until Nixon’s action in 1971 and in 1974 Gerald Ford signed legislation permitting Americans to once again own gold. This was also the beginning of trading gold futures contracts on the COMEX exchange and the price of gold was now determined by the free market.

Gold As an Investment in Isolation

Calculating the rate of return on gold since Nixon’s decision is not terribly difficult. Gold does not pay dividends or interest, and is not subject to stock splits or other corporate actions. All we need to look at is the price in 1971 compared to today and do the math.

Gold was $35 an ounce in 1971 and we’ll use the high point of $2,065 from 2020, that spits out an annualized return of 8.68%. $10,000 worth of gold in 1971 would be worth over $590,652 today. That sounds attractive for an asset that doesn’t have much correlation to stocks or bonds. There is more to the story though.

As I mentioned above the government had fixed the price of gold at $35 an ounce for 37 years. Gold compounded at over 36% annually from 1972 – 1979 while adjusting to real world price setting.  If instead we use a 1980 start point for calculating the return of gold, then through July of 2020 it has only earned 3.21% annualized. But maybe that isn’t a fair starting point either?

To get a better understanding of gold’s performance, using a start date of 1934 and $35 an ounce might tell us more. That gives us an 86 year period where gold went from $35 to $2,065, which is an annualized rate of 4.86%, not too shabby. For perspective, reported annualized inflation in the US was 3.50% from 1934 – 2019. For comparison, the US stock market earned 11% annualized from 1934 – 2019 as measured by the CRSP 1 – 10 Index.

Those returns may be somewhat beneficial to gold, since I gave the benefit of using the all time high price. There have been periods where gold has been quite an awful investment. Had you purchased $10,000 worth of gold on January 1, 1980, you would have had $10,019 on December 31, 2005. That is a nice annualized gain of 0.01% for a 26 year period. Inflation during this period was 3.70% annualized, so the inflation hedge did not quite work.

Owning gold from 1980 – 2005 would have caused you to lose 60%+ of your purchasing power, while owning riskless one-month Treasury bills would have beat inflation by 2% annually.

If you draw up a financial plan today that your one-month Treasury bills will beat inflation by 2% going forward, you may be sorely disappointed (current one-month T-Bill rate is 0.10%).

Past performance does not equate to future results, and the world is different today. The Federal Reserve is currently taking measures that are unprecedented that has led some investors to view gold as a good alternative. Speaking candidly, most alternative investments suck. They charge high fees, provide low returns, and are illiquid. Gold can be invested in without high costs, is liquid, and shown periods of decent returns.

Like treasury bills, past performance of gold is unlikely to be indicative of future results. Further, looking at gold in isolation is not how we should view it as an investment, yet in the context of a more diversified portfolio. Before we look forward at whether or not gold can have its place in your portfolio, first let’s look and see how it would have helped or hurt in the past.

Does Investing in Gold Make Sense?

Given that gold has had a positive return and has little to no correlation to stocks or bonds, there may be a case it can fit into a diversified portfolio. Let’s look at a few sample portfolios over different time horizons and see the impact from investing in gold. Our base portfolio will be 60% US stocks, and 40% intermediate term treasuries. In order to not cherry pick, any allocation to gold will be taken from each of these assets proportionately. All of the performance data is generated from Portfolio Visualizer.

Portfolio 1 = 60% US Stock Market, 40% Intermediate US Treasuries

Portfolio 2 = 54% US Stock Market, 36% Intermediate US Treasuries, 10% Gold

Portfolio 3 = 48% US Stock Market, 32% Intermediate US Treasuries, 20% Gold

Each portfolio will be rebalanced annually, and we will look at a few different time periods.

Investing in gold hurt the portfolio returns here but it still decreased some of the downside risk in each portfolio it was added. What gold did in each of these different time periods was provide a low correlation to both stocks and bonds. What may surprise some people is that gold in itself experienced a much larger max decline from 1972 – 2019 (-61%), and much higher volatility than either stocks or bonds did, and an abysmally lower return than stocks or bonds in the second time period.

Even though it was a riskier asset with a lower return, adding it to a portfolio actually decreased the risk a bit since it was not correlated to the other assets.

Going Forward

Why did I just review past performance when I mentioned it is not indicative of future results? It is still important to know the history of an asset, and some of the historical range of outcomes before you consider investing in it.

When it comes to investing in gold or anything else, the future is always uncertain. While many people are concerned about the US debt, interest expense as a percentage of GDP at the end of 2019 is only 1.75% (which is far below the 3%+ average during the 1990s, low rates helps).

Adding 5% – 10% of your portfolio to gold probably will not move the needle much in either direction enough to make a difference, and adding 20% – 30% of one’s portfolio to gold might be terribly uncomfortable for one to do. Gold is not an asset I advise people from owning, but as we’ve seen there can be terribly long periods of no return (as there have been for stocks and bonds as well) while owning gold, so you must have a strong conviction in it and be in it for the long run.

Peter Schiff may tell you there no other place to put money besides gold. Myself, I have a stronger conviction in the long-term profit incentives of corporate America than I do in a shiny piece of metal.