The Place of Gold in an Investor’s Portfolio

What image do we conjure up when we think of Gold? Elegance, beauty, wealth, risk, insurance, or just another shiny metal? But do we think of Gold as money? Money must be a store of value, a medium of exchange and a unit of account. The function of money in our financial system allows us to trade without needing to ‘barter’. (Selling a jacket for a loaf of bread!)

Money has taken different forms during millennia from Gold, feathers, shells, coins, paper (FIAT), and now digital (Crypto). Confidence in the unit of exchange is what they have in common. Gold has performed this function for 5,000 years unlike crypto which has still to be tested in a crisis. But is this true today? What relevance can a lump of metal possibly have in a technologically driven 21st century marketplace? Markets are simply a reflection of human endeavour and behaviour. Scarcity, permanence and independence are attributes unique to gold lacking in our modern financial system.

Fear and greed drive markets and this can be seen by studying the historical movement of the gold price. When investors are fearful, they buy gold as an insurance against systemic loss. However if insuring against systemic risk in the financial system, gold must be held outside that system. No use plugging your backup generator into your mains when the power supply fails.

The USD has depreciated against Gold 98% since 1900. Gold has retained its purchasing power over millennia. In this context it is not the price of Gold that matters but how the value of FIAT printed money depreciates against Gold. All the Gold ever mined is held by someone and is approximately USD 7 trillion, of which Central Banks hold approximately 10%. Gold for the Central Banks is their liquid reserve for a financial crisis. In the US stored under armed guard in Fort Knox and West Point and in China guarded by PLA in a mountain somewhere. However, unlike paper money, which is a claim against the central bank, Gold is the only asset which is not someone else’s liability and does not require a financial intermediary.

In addition to insurance against systemic risk, Gold is not correlated with other financial assets like bonds equities and commodities and acts as a diversifier of market risk in a portfolio. For example, the price of Gold moves inversely to the USD and acts as a hedge against inflation. In a time of excessive government indebtedness, erratic investor behaviour and a highly leveraged credit market as a result of the cheapest money for 100 years, prudent investors will follow the lead of central banks and include a holding of gold as part of their investment portfolio. The price of gold has appreciated 20.62% over the last 12 months and 493% since 2000. How we should own gold and how much is another question for another article.

Jeremy Blatch TEP
Society of Trust and Estate Practitioners Logo