Why You Need What No One Wants

There aren’t too many investments selling today at their 2010 prices. Not the stock market, up more than 100% since then. Or the bond market, lower in yield by 50% and therefore much higher in price. Or real estate which has surged broadly since that time. What’s left? Gold!, the investment that is fast becoming completely unloved. Why own gold now, or even at all? Let’s take a closer look.

You’re in good company
If you have invested in gold over the last several years only to see its value go down and down again you are not alone. Hedge fund biggies like John Paulson and David Einhorn have suffered mightily for their gold affection. Their investors expect opportunistic positive returns year after year. Gold has delivered the opposite. Einhorn’s Greenlight Capital Re is down 16% already this year.

What, exactly, is gold?
My all time favorite quote about gold comes from former Fed chair Ben Bernanke: “Nobody really knows what determines the price of gold.” Truer words, Ben, but where does that leave investors? The answer is that you don’t have to know what determines the price of gold to know how it helps a portfolio. Gold is 1) a unique portfolio diversifier truly uncorrelated with all other investments 2) the oldest medium of exchange in the world, 5000 years and counting 3) uncorruptible – it can’t be forged, duplicated or 3D printed by flailing central banks.

What gold is not
Goldbugs say gold is the ultimate doomsday investment. If all Hell breaks loose everyone will want gold. Inflationists say gold is a hedge against rising prices. Purists say gold is the only true money and that all that government paper is really worthless by comparison. In fact, there is almost no correlation between any of these theories and the price of gold. Gold has gone up 7.8% per year, or 31X since modern times began in 1971 with the unpegging of gold. When it peaked at $1900/oz in 2011 that annualized return was 10.0%, or 54X. But it has gone up and down in the most irregular and unpredictable fashion. And that’s exactly what makes it valuable in a diversified portfolio. Wait, what?

Gold does not pay an annual dividend or announce quarterly earnings like corporate stocks. It’s not intrinsically tied to interest rates like bonds. It marches to its own beat, its price driven solely by supply and demand. That means it rarely moves in concert with other elements in a diversified portfolio. Its lack of correlation – its difference from the crowd – is its special value. Because it’s not likely to move in the same direction as other securities it mediates the risk of a diverse portfolio.

In other words, like it or not, it’s been behaving about as expected by doing its own thing.

Haters gotta hate
Let’s not mince words: gold is now the last kid picked for the team. It’s almost universally unloved. That’s natural when a large asset class ($6 trillion, the value of all gold ever mined) goes up and up, then down and downer. First euphoria then regret then disgust. Other than a few remaining big hedge fund positions, I can find almost no credible examples of anyone who likes gold, recommends gold or thinks gold is a good long term investment. However, realize that there is lemonade to be made from the lemon gold has become right now. We’ve been anti-taxing all along to realize gold losses to offset gains in client accounts. That can add up to 44 cents on the dollar in lower tax bills. 

Should you own gold ?
Yes. Gold is an alternative investment, along with real estate. Because of low correlation with other elements, I believe alternative investments belong in every diversified portfolio. How much gold? Enough to bring your asset allocation back to its original setting. Rebalancing back to your target allocation may be painful but rebalancing is how long term investors keep and grow money. If you own only what’s popular and has a near term winning record you end up holding just one asset class – and that’s the easiest way to increase portfolio risk and miss major upside asset class moves. Think how unloved stocks were in 2009. Or bonds in 2008. Or gold in 2005 before it went up 70% in 2006.

Emotionally it may not be easy to buy more of what’s been performing worst, but that’s what rebalancing is. Gold is sending an important message right now: pay attention to the balance in your portfolio and stay in line…at 2010 prices.

John Osbon – josbon@osboncapital.com