Key Questions: Is all that Glitters Truly Golden?
How Key Private Bank views gold.
Spanning thousands of years and transcending a diverse terrain of geographies, gold has attracted fascination and speculation like no other investment. In his famed book on the topic, legendary economic historian Peter Bernstein said it so incredibly well: "Gold has been an icon for greed and an emblem of rectitude, as well as a vehicle for vanity and a badge of power that has shaped the destiny of humanity."
Moreover, gold often triggers emotions ranging from unyielding affinity to utter disdain. Warren Buffett, for one, is certainly not a believer. In 1998, the Oracle of Omaha stated: "(Gold) gets dug out of the ground. 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."
Conversely, it’s not uncommon for "goldbugs" to vigorously warn of an impending crisis and implore investors to buy as much gold as possible at any price. Such an extreme range of viewpoints can create challenges for investors to understand gold as an investment and its potential uses within a portfolio.
Key Private Bank views gold as an alternative store of value that can retain real purchasing power during hyper-inflationary conditions, currency devaluations, or periods of high uncertainty. However, because such periods are rare and unknowable ahead of time, we do not believe that gold warrants constant exposure in an investment portfolio, unlike other asset classes such as stocks and bonds.
As evidence, over the last several decades gold and bonds have generated comparable returns. This period spans both the highly inflationary 1970s in which gold outperformed and the proceeding disinflationary/slow growth era in which bonds meaningfully outperformed. That said, gold prices were nearly four times as volatile as bond prices. Equities, meanwhile, outperformed both gold and bonds, and did so with one-third less volatility than gold.
Looked at differently, in the last forty years, bond prices generated positive calendar-year returns 90% of the time. Stocks did so 83% of the time, but gold prices did so only 58% of time. In other words, gold prices are extremely volatile, and while gold stands to benefit from episodes of excessive uncertainty, the ability to accurately foresee such is dangerously difficult to achieve.
Furthermore, unlike stocks and bonds, gold does not offer investors a stream of cash flows in the form of dividends or interest payments, nor does it benefit from collective human ingenuity that creates valuable goods and services that are manifested in the form of corporate profits accruing to investors’ benefit.
Also, while it is not typically used as a medium of exchange, gold should be viewed more as a currency compared to a commodity. This is confirmed by global central banks that hold large quantities of gold as reserve assets. And most notably, gold has little functional value other than as a store of value for investors. In brief, it is an insurance hedge that some investors might be willing to pay for, but many may lack the ability to do so and endure prolonged periods of underperformance.
For these reasons, we reiterate our belief that gold does not merit a permanent allocation within an investor’s portfolio. Still, it is worth asking: What conditions could trigger a tactical recommendation to gold?
If US interest rates decline to zero or below, investors may need to consider other diversifying assets that have some expectation of adequate nominal returns on a forward-looking basis. And if interest rates fall to zero or below, prospective fixed income returns are likely to be very low or even negative for a persistent amount of time.
Another scenario that could favor gold is if coordination between the Federal Reserve and the federal government increases in order to finance expanding budget deficits. Modern Monetary Theory or aspects of MMT could be adopted to foster economic growth. In this scenario, gold could be a favorable hedge to the increased risk of a fall in the dollar’s value.
For now, however, Key Private Bank’s economic base case is for slower but continued growth with subdued inflation. The risks to stocks and bonds are balanced, warranting a neutral allocation. Given our outlook, we believe stocks and bonds and other diversifying strategies are preferred over gold.
For more information, please contact your Key Private Bank Advisor.