Should gold be a part of your portfolio?

Gold as an investment asset has many detractors. Here’s a quote from author Alain Guillot that sheds some light on why he keeps his distance from the yellow metal:

Quite a pessimistic assessment, isn’t it?

What the data reveals

However, if we look at gold’s performance over the last 25-odd years, it turns out that the metal has delivered better returns than equities not only in developed countries (where stock market returns tend to be relatively low) but even in emerging markets (where stock market returns can be quite high).
For instance, as the table below shows, since the start of this century, gold has done better than equities in developed markets such as Japan, France, Canada, the UK, and the US:

For the same time period, gold also beat equities in a large number of emerging markets, as indicated in the table below. It’s worth noting that India beat this trend, but only narrowly.

So this data seems to support what gold proponents have been saying for a long time: that gold serves as an excellent hedge against tough times.

And quite often, such tough times are the outcome of poor decision-making by governments — what we could call ‘sovereign stupidity’.

The impact of sovereign stupidity

One of the most primary drivers of gold’s global performance over the past 25 years has been central banks’ monetary policies, particularly in the wake of the 2008 Global Financial Crisis (GFC).

Yes, the GFC was a complex event with multiple causes, but the US government undoubtedly had a major role in creating the conditions that allowed it to happen.

While US lawmakers pushed to improve access to homeownership and took a relatively hands-off approach to the financial markets, the Federal Reserve’s monetary policy made it easier to borrow money (and thus, to engage risk-taking behaviour). Moreover, the SEC failed to take action against novel and highly risky financial instruments in good time.

Once the GFC had struck, central banks in developed markets implemented policies that flooded the financial system with liquidity, leading to the depreciation of fiat currencies and concerns over inflation.

Since gold is typically used as a store of value and a hedge against inflation, investors flocked to it during this time.

Gold prices increased significantly from around $700 per ounce in 2008 to around $1,900 per ounce by 2011. Over the same period, while equities did recover from their 2008 lows, their returns were more moderate compared to gold's gains.

Moreover, while the GFC had repercussions across global markets, the last 25 years have also seen several instances of sovereign stupidity with more localised effects:

• The withdrawal of the UK from the EU (“Brexit”)
• Argentina’s debt crisis in 2001, which led the country to default on its sovereign debt
• The 2016 coup attempt in Turkey and the sharp devaluation of the Turkish Lira
• Brazil’s economic crisis from 2014-2016, partly caused by political instability and poor economic policies.

It’s the nature of such stupidity that it’s as clear as daylight in hindsight, but very difficult to discern in real-time.

And that’s exactly why many investors feel so strongly about having some gold in their portfolio: when government action plunges markets into darkness, it’s the lustre of gold that comes to the rescue.

For more actionable insights backed by data and analyses, we invite you to read the latest edition of Netra in its entirety.