All that glisters…

All that glisters…

“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.”

Warren Buffet

Gold has always held a certain appeal for humans.  Its lustre, due to a lack of oxidation, makes it pleasing to look at and to handle.  Yet it is simply a lump of metal.  We are often asked why we don’t include gold (or any other commodities for that matter) in our model portfolios.  The simple answer is because gold and other commodities have no expected return – they pay no income, and will only be worth what someone else wants to pay for them at any point in time.  Given the lack of cashflow, common valuation models are not useful, therefore it’s no wonder that Warren Buffett is not a big gold fan.

Gold has suffered prolonged and negative real returns over periods as long as 20 years and delivered an annualised return of just 1.5% p.a. after inflation – around 5% lower than equities – between 1987 and 2017, yet with comparable volatility.  In its favour, gold prices are uncorrelated to equity markets.

Yet many investors seem enamoured by its fabled investment properties.  So, do the claims in favour of including gold in a diversified portfolio stack up?


Claim 1: Gold is a good defensive asset at times of global equity market crisis

In the period under review, there were three substantial equity market crashes, shown below in declining magnitude.


Figure 1:  Gold as a defensive asset from 1/1979 to 6/2017

Data source: MSCI World Index (net div.), Citi WGBI (1-5) hedged GBP from Morningstar © All rights reserved.


The spectacular return of gold during the credit crisis was perhaps driven by fear, pushing up its price.  If you can guess how others are going to behave in the future, you would be able to take advantage of gold’s hedge against fear, buying and selling it at appropriate times.

However, market timing is exceptionally hard to do without the luxury of hindsight.  Holding gold as a strategic diversifier in a portfolio carries with it a punitive long-run zero real return assumption.  Gold may be a good hedge against fear but it is hard to exploit in practice.


Claim 2:  Gold is a good inflation hedge

Perhaps one of the most quoted properties of gold is its supposed ability to provide a hedge against inflation.  The evidence does not support the assertion, at least over normal investment horizons.

Over the long-term gold keeps up with inflation; A US Army private gets paid almost the same – in terms of gold – as a Roman legionary did 2,000 years ago!

The belief that gold is a good inflation hedge is anchored on its performance during the late 1970s, when gold prices and high inflation rose in tandem.  James Montier of GMO undertook an analysis that demonstrated the 10-year inflation for each decade and the gold price return were uncorrelated except for in the 1970s[1].  In terms of an inflation hedge, stocks and index-linked gilts provide better opportunities to achieve this objective.


Figure 2: The real price of gold and underlying annual inflation 1/1979 to 6/2017

Data source:  UK Retail Price Index – Bank of England


Claim 3: Gold is a useful store of wealth in an Armageddon scenario

A case can perhaps be made for holding some physical gold in the form of coins or ingots in the liquidity reserves of those who fear the breakdown of fiat (paper) currencies at times of extreme market events, such as those surrounding the collapse of Lehman Brothers or even greater global calamity such as another world war.

In the extreme collapse of the financial system, paper gold (e.g. via a gold fund or ETF) would be less favourable given the risk of counterparty failure and the potential inability to access the underlying gold when it is truly needed.  Don’t forget that gold is very heavy and if you bury it, you need to be able to find it again; our museums are full of gold Roman coins that were buried and lost two thousand years ago!

Ultimately, where gold advocates see a safe harbour, others just see a different set of rocks to crash into.  Since gold generates no return, the only way today’s fearful investor is going to see an appreciation from this asset depends on him finding an even more fearful buyer tomorrow.



Buffet had more wise words to say on the issue in his Berkshire Hathaway 2011 letter to investors:

“Today the world’s gold stock is about 170,000 metric tons.  If all of this gold were melded together, it would form a cube of about 68 feet per side (picture it fitting comfortably within a baseball infield).

At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion.  Call this cube pile A.

Let’s now create a pile B costing an equal amount.  For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually).

After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge).

Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be.  Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons).  The 170,000 tons of gold will be unchanged in size and still incapable of producing anything.”

Enjoy your gold jewellery, perhaps hide a few Krugerands in the airing cupboard, but don’t believe that owning gold will improve the structure of, or expected return from your portfolio.  From an investment perspective, all that glisters is not gold.


“Gold belongs only in the portfolios of fearmongers and speculators.  If you own gold in your portfolio, expect to not get paid an income, pay higher taxes on your returns, take a more volatile ride than the stock market and get a long-term return lower than bonds.” 

Peter Malouk, ‘The 5 Mistakes Every Investor Makes and How to Avoid Them


Warm regards



[1]           Montier, J., (2013) No silver bullets in investing (just old snake oil in new bottles), GMO White Paper, December 2013