by Pat Garrett We’re sometimes asked why Six Park does not use gold as an investment in our portfolios – and we heard this a bit more during 2020, when the price of gold had a precipitous rise and subsequent sell-off during a time of high market volatility resulting from the COVID-19 pandemic.
Is buying gold a good investment?
Six Park continuously reviews all forms of asset classes in the consideration of portfolio components. We recognise what gold can and can’t do. While we don’t think it’s silly to invest in gold, we do believe there are better asset classes out there for medium and long term investors.
Here we explain the 3 reasons why Six Park does not use gold in portfolio construction.
Key points:
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1 . Gold does not pay any income
For medium- and long-term investors, we believe the ability to generate income, such as dividends, is an important feature of any asset class, especially if it’s meant to be defensive in nature.
Such income helps reduce overall portfolio volatility and smooth out portfolio returns during market cycles both up and down. Income-generating defensive assets also unlock the power of compounding interest on income generated over the life of an investment.
Gold’s performance over time is only due to price/capital appreciation, rather than the addition of dividend and interest income that stocks and bonds typically provide.
Though an admittedly short window of time, the past 16 months demonstrate this point.
Since 1 January 2020, global markets have been extremely volatile, and those investors who held their nerve received income from stocks and bonds, as well as a strong recovery of capital value.
After a sharp rise in value, the price of gold (and gold ETFs in general) gave back a majority of the initial gains during the second half of this period (down 15-20%) as global markets recovered, without any form of income during this time.
Gold investors who stayed the course saw an attractive gain early in this cycle, to be materially reduced without any locked-in income gains along the way.
This was more so true for ASX-listed gold ETFs as they were also negatively impacted by movements in the foreign exchange rate.
2. The long-term performance of gold is not compelling enough given its volatility and lack of income
When gold prices jump (typically during times of severe volatility), it can draw a lot of investor interest.
However, the periods of outperformance of gold tend to be relatively infrequent and unpredictable when compared with share market returns over time.
This dynamic is reflected in performance figures below (price of USD gold versus Dow Jones Industrial Average, DJIA) over 5-, 10-, and 30-year horizons as of May 9, 2021.
So, while gold can experience periodic windows of strong gains, these tend to be bookended with periods of modest capital appreciation without income.
On balance, our assessment is that the expected returns of gold over time do not justify the risk of its inclusion in portfolios, especially when weighed against the combination of other growth and defensive asset classes.
Additionally, in Australia, it is not possible to get hedged ETF investment exposure to gold. So, investing in gold adds unhedged portfolio exposure, which introduces more volatility as a result of currency fluctuations. This can impact returns as seen this last year when the AUD:USD exchange rate rose from 0.64 to 0.78.
3. Gold’s “safe haven/store of wealth” status has led to elevated volatility in the past and is questionable going forward
Gold has typically been viewed by some as a hedge against inflation, as well as against a material share market fall. Whilst this has been true on some occasions, we believe that the relationship between gold and that of share markets, inflation and interest rates remains ambiguous.
Supply and demand drive a large portion of the price of gold rather than the application of capital or labour. This means the price of gold is highly dependent on investor behaviour and sentiment versus other investment fundamentals.
Many investors turn to gold during market turmoil as a ‘safe haven’ investment. This can make it a far more volatile (with 2020 as an obvious example) investment than we believe is worth the commensurate expected returns over time.
As for inflation, we believe that a globally diversified portfolio has, by its nature, a measure of protection against inflation since share global dividends typically grow with economic expansion.
We’ve observed some investors using gold as more of a short-term tactical hedge against a “crisis” environment, more of an insurance policy. We do not think that it is in the best interests of our clients to deploy any of their capital over the medium- to long-term in this way. Such activity suggests that gold is more of a speculative, market timing-based investment decision, which is extremely difficult to get correct over time and not consistent with Six Park’s long-term investment philosophy.
Conclusion
1. The overall investment performance of gold is very time-dependent and typically underwhelms when considered over the long term. In our view, periods of outperformance are too infrequent to warrant ongoing exposure to gold as an asset class.
2. We believe that gold is an unnecessary drag on overall portfolio performance and that there are more efficient ways to achieve an optimal asset class investment mix with other growth and defensive investments.
3. It is also our observation that a majority of professional asset managers do not include gold as an asset class for similar reasons.
Six Park portfolios are built using exchange-traded funds (ETFs) which, by their nature, are diversified. Using ETFs means you’re buying into literally thousands of companies, sectors and assets – instantly and inexpensively delivering a truly diversified portfolio through a single investment.
Your portfolio can be diversified across asset classes, sectors, and industries, with many providing dividend income.
A final word: Be careful about following the crowd
In the past 12 months, we’ve observed some retail and institutional investors adding gold after a significant price increase during 2020.
This is arguably an example of investors ‘chasing returns’, buying an asset after a run-up in price, which was likely magnified by the emotional nature of investing in 2020 during highly volatile markets. The ASX-listed gold ETF is now down almost 20% from its 2020 highs, whilst the rebound in global share markets during the end of 2020 and early 2021 has rewarded the patient investors who stayed the course and earned dividends and interest during this period.
At Six Park, we believe it’s tough to ‘pick winners’ or ‘time the market’ in a way that consistently and meaningfully beats the market. Instead, we believe the best approach is to focus on passive, broad-based index funds like ETFs – to buy the market, rather than try to beat it.
This article may contain general financial product information but should not be relied upon or construed as a recommendation of any financial product. This information has been prepared without taking into account your objectives, financial situation or needs.
For further details on our service please see our Financial Services Guide at http://www.sixpark.com.au. Past performance is not a reliable indicator of future performance.