What is the Value of Gold in Your Portfolio?

Gold has a complicated investment history, holding a privileged position despite how difficult it is for investors to gauge its true value. Whether the yellow metal is a worthwhile investment remains a matter of much debate – and what is true value of gold isn’t a question that has been positively answered.

Does gold have a place in an investor’s portfolio?

Unlike financial assets, gold pays no dividends, makes no commitment to pay interest or repay invested principal, and collects no rents.

Gold is not a commodity in the sense that it does not grow with the seasons and only to a very minor extent is consumed in a manufacturing process.

Gold mostly just sits – in a jewelry box or safe, maybe with a central bank, occasionally on a lady’s ankle. Often it attracts insurance and storage charges.

Why does the portfolio question even come up?

The “value” of gold is only inherent in the desire of people (investors, speculators, true believers, central bankers) to buy and hold it.

Given the characteristics outlined above, why do people hoard gold?

In jewelry, it can be beautiful. In times of social stress, it has sometimes proven to be a lifesaver. Throughout history, gold has provided evidence of wealth and power, and often a means of effecting transactions, paying ransoms and the like.

More recently, nations held gold as backing for paper currencies and evidence of monetary rectitude – a period that ended in 1971 when the United States ended the convertibility of dollars into gold.

Currently, with the massive expansion of global trade and international financial transactions at the click of a mouse, the idea of relating such vast financial flows to a hoarded metal inert in a vault seems ludicrous.

And yet, there remains a lingering residual memory of the history of gold retaining purchasing power through many centuries.
History is clear – governments will eventually debase the currency of the moment. Romans regularly reduced the gold content in their coins, substituting tin. Inflation has done the damage in too many instances to enumerate. War, revolution and corruption are rampant through history – always with the result that paper money is diminished.

Peter Bernstein, the noted economist and financial historian, wrote a wonderful history in 1999 titled, The Power of Gold: The History of an Obsession. His subtitle hints at his thesis: In spite of a long historical trend of rising price, the quest for wealth through gold has persistently brought the seeker down.

“The most striking feature of this long history is that gold led most of the protagonists of the drama into the ditch … All were fools for gold, chasing an illusion.”

An example that should give even the most ardent believer in gold pause: In April 1933, the U.S. government confiscated all the gold held by its citizens at $20.67 per ounce, with severe penalties for non-compliance. In January 1934, a new price of $35 per ounce was set, but only for intergovernmental transactions and without compensation for the citizens who had been disgorged.

A dispassionate observer must conclude that gold can have two potential roles in a portfolio: an investor with an intergenerational time horizon, building for her grandchildren might choose to hold gold as insurance against the inexorable degradation of paper, confident in the long-term lesson of history but remaining cognizant of Bernstein’s caution; or as a trading position bought when long suffering holders are desperate to sell and sold when buyers line up to acquire gold.

Consistently profiting from this latter contrarian style of speculating is psychologically difficult. Most experts will say it’s impossible.

Gold is the perfect example of what George Soros would consider a reflexive speculation. There is no way to establish “value.” Trends in price will self-reinforce and go to vibrant extremes of pessimism and optimism.

In 1980, gold exploded to $900 per ounce in a frenzy of inflationary psychology – about 25 times the price that prevailed just after former U.S. president Richard Nixon freed the dollar from the barbarous relic.

Twenty years later, as Bernstein was sending his history to the printers, gold was trading around $300, pressed to that level by relentless central bank selling.

A short eleven years later, in the aftermath of a financial crisis, when helicopters replaced probity as the central bank weapon of choice, and when institutional pools of capital salivated over “alternative” investments, gold crested at $1900 an ounce.

And so, writing in mid-2016 with gold in the $1200s, where would a trader stand when it comes to the value of gold?

As ever, no slender reed of “value” provides comfort. Central bankers are certainly misbehaving – doing their best to create inflation and debase currency values (a seemingly improbable objective in the relativistic world of currencies). That’s a strong positive for gold.

But there has been no mad rush for the exits that would justify a contrarian bid. Five years of declining prices may have been sufficient to shake loose institutional alternative positions.

A contrarian trader would hope for a lot more emotional selling to place a big bet.

That may yet come.

4 years ago