Gold, dear Gold

Gold, dear Gold


Ray Dalio’s optimistic call has recently drawn the attention to gold in view of the strong record of this investor and of his hedge fund Bridgewater Capital.

Since the dawn of humanity gold has fascinated man with a universal appeal. It has been the symbol for wealth and prestige. Gold’s attraction has been driven by its beauty, rarity and transcendence as it basically does not rust or tarnish over time.

Until the 1970s global wealth was tied to gold. In ancient times trade was handled in coins of gold, silver and other precious metals. Eventually paper currencies were initially created based on the gold standard meaning that they were backed by physical gold. However this system was suppressed by Nixon in 1971 as the whole Bretton Woods international monetary system fell apart. Since then, all the paper currency are “fiat currencies” no longer backed by any physical asset and depending solely on the good will of the central banks that can increase or decrease money supply.

It is noteworthy that the total quantity of gold that has been extracted over history is small. According to the majority of estimates it is 150’000 to 170’000 tons. This quantity could fit in a single tennis court deep about 10 meters ,see illustration below (1).

Gold price is very hard to predict

The complexity of forecasting the price of gold is due to the fact that it depends on several factors which are all affected by considerable uncertainty.

India has a considerable impact on the market as Indians are still generally favouring gold as a preferred store of value. However, as the country develops the population becomes also increasingly reliant on the banking system which could potentially dampen the demand for gold. The market also has some self-stabilization feature since people tend to recycle or sell down some of their gold holdings when prices go up.

The other driver for gold are financial expectations of investors world-wide. Gold has historically done quite well in times of inflation and is therefore perceived as an inflation hedge. Even in the absence of inflation low real interest rates let alone the current negative interest rates support gold. When putting money on the bank account generates little or even negative income the relative attractiveness of owning gold goes increases. In addition gold is also seen as a safe haven in times of political tensions at the national and international level although it is not immune to the economic situation.

A further important driver of the gold market are central banks. As parts of their reserve diversification they own gold in addition to major currencies such as the dollar or the euro. When the dollar weakens they have an incentive to increase their gold holdings in order to preserve value. In addition, political consideration can also play a role particularly when major players such as Russia and China are not particularly fond of the American political power embedded in the dollar due to its role as the world’s reserve currency.

Gold is also cyclical and while price increased markedly there is further upside potential.

Current outlook looks positive

As complex as forecasting gold price is, at present all stars seem positively aligned in gold’s favour. While there is little inflation the negative rates which affect a major part of the world and could potentially spread further are potentially supportive. The allocation to gold in portfolios is currently low meaning that a small increase in allocations could induce a significant price increase. As a short term tactical play in the current environment, gold is likely providing diversification and hedging benefits to an investment portfolio as Dalio suggests.

For the long-term investor quality financial assets are better

In a long term perspective the situation is very different though. Contrarily to equities, bonds or real estate, gold generates no income. Historically it has performed extremely weakly compared to equities.

At Berkshire's 2018 annual meeting, Warren Buffett compared $10,000 invested in stocks and gold in 1942 (the first year he invested in stocks). That money invested in an S&P 500 index fund would've been worth $51 million in 2018 while a gold investment would've been worth only $400,000. 23 In other words the value of the stock market investment would be 125 times higher! The same holds true for longer or shorter timeframes. So while gold indeed went up it did very poorly compared to the stock market.

When considering gold’s role as an inflation hedge one should also remember that there are other ways to hedge against inflation. High quality real estate investments usually benefit from inflation as do a number of listed companies. At the same time they offer a running yield in terms of rents or dividend payments and capital appreciation potential.

In conclusion, we believe that in the current market circumstances a limited allocation (2-5%) can make sense but is in no way a must. Despite all the talk Bridgewater’s allocation in its relevant fund is currently modest (around 5%). The long-term investor looking to increase his capital over time is better served by holding quality assets that generate income and increase in capital value over time than by owning gold which remains a cyclical and speculative asset.

Orit Raviv Swery Ilan Weil

Founder & CEO Chief Investment Officer