Gold

Most investment professionals are aware of the arguments for and against gold as an investment, and many hold strong opinions on its merit.  One way to categorize investments is that they may be held with one of three objectives:  as a short term trade with pre-determined price or other limits related to the position itself, a tactical position with specific buy-sell criteria based on macro or other data not as directly related to the position itself, or buy-and-hold, with sell criteria based on time and portfolio characteristics.

By considering gold in this way, there are very specific pros and cons:

Short term trade:

• CTAs commonly trade gold using technical criteria, as it is a commodity.
• It has been possible in the past to find success with trading systems that take advantage of known patterns (daily price fixing in London, for example).  However, with the advent of global round-the-clock trading, these patterns are becoming harder to find and exploit for the small trader.
• Gold is not an income producing asset.  In fact, unless you are holding the physical gold, you will have to pay someone to hold it for you.  This makes it difficult to value using fundamentals, although there are many ways that “correct” gold prices have been determined by analysts.

Tactical position:

• Hedge inflation.  Although this is frequently an argument made in favor of holding gold, the data and research conclusions are decidedly mixed on this point.  Here is Vanguard’s take:  https://personal.vanguard.com/pdf/icruih.pdf   This paper finds conclusive evidence in favor of gold: https://www.researchgate.net/publication/273542920_Gold_as_a_Hedge_against_Inflation_The_Vietnamese_Case  and this one finds conclusive evidence against gold:  http://web.usm.my/km/33(Supp.1)2015/Art.5%20(69-84)edit.pdf
• Insurance against apocolyptic events in the financial, political, and/or physical world.  Your gold asset is not someone else’s liability.  This only is true if you are actually holding physical gold.
• Insurance against large, unexpected, but not necessarily catastrophic events in the financial world.  This might include large scale debt defaults by governments or others, revaluation or substitution of currencies, or unexpected, high, and persistent inflation (but not hyperinflation).

Buy-and-hold:

• Diversification.  Over the last 10 years, the 60-day correlation between GLD and SPY has ranged from -.63 to +.67, with a majority of the last 5 years in negative territory.  The correlation between GLD and AGG has been -.32 to +.76, mainly below .5.  (Source:  etfreplay.com)
• Historical value.  Everyone “knows” that gold will always hold its value.  Cost of a suit in ancient Rome, etc.  This faith in gold is similar to the faith placed in fiat currency, like dollars or bitcoin.  Another similarity to currency is that gold has few industrial uses, and is mainly held as either jewelry or purely to store value.

One fact regarding gold is that its return is highly volatile, and perceived mis-pricing can persist over long time periods.  This is an argument in favor of short term trading and some tactical positions, but against buy and hold as well as other tactical strategies.

In today’s market, the best argument in favor of an allocation to gold is tactical.  It’s not a wild conspiracy theory to be concerned about the central bank balance sheet or levels of government debt, which are not just a US but a global phenomenon.  On July 30, Jamie Dimon, chairman and CEO of JP Morgan Chase, was quoted in USA Today:  “I don’t want to scare the public, but we’ve never had QE,” Dimon said. “We’ve never had the reversal. Regulations are different. Monetary transmission is different. Governments have borrowed too much debt, and people can panic when things change.”  It may become apparent over time that QE reversal is not an issue, just as time has proven that the mere existence of all that extra money did not cause a hyperinflation.  It may also become apparent over time that governments are finding ways to deal with their excess debt and other obligations.  If you decide that gold is a good way to hedge these risks, be sure you also have an exit strategy.  Otherwise this becomes a buy and hold position, which is not likely to result in positive real returns.