Gold- Good Protection In A Crisis, But A Castle In The Sky

 |  Includes: GLD, IAU
by: Anthony J. D'Asaro


Gold is one of the best insurance policies against extreme crisis, which makes it attractive as a portfolio diversifier.

However, with no "fair value", gold is susceptible to bubbles, which makes it unpredictable and doesn't lend itself well to logical portfolio construction.

At best, gold should be a medium-time horizon tactical investment, always keeping in mind that sentiment drives price.

The "economic collapse" argument for gold doesn't hold up under scrutiny.

Gold is one of the best insurance policies against a severe financial or inflationary crisis, which makes it attractive as a diversifier to traditional portfolios. Gold's tendency to spike during crisis times (when every other asset is on a fire sale) makes it extremely valuable. Based on modern portfolio theory, gold's negative correlation during crisis periods makes it so valuable, that even if gold slowly declined in value over the long term, one would still want to hold a significant allocation to it in an optimized portfolio.

Given that value, wouldn't investors want a permanent allocation to gold?

The major problem with gold is that because it is inherently unproductive (it just sits there), unlike other investments that produce cash flow or interest, there is no way to establish a "fair value." Instead, the price of gold floats, like a castle in the sky, which could easily rise further or come collapsing down at any moment. With restricted supply, gold moves around based on whimsical investor demand, and is subject to:

1. How much positive or negative media coverage gold is getting.

2. How much gold brokers are spending on advertising.

3. How much income people who invest in gold are earning.

4. Greed

5. Fear of losing your investment.

Essentially these 5 items center around a single theme: How popular is gold? And like any other popularity contest, gold is susceptible to rising and falling investor sentiment, bubbles, and just like the stock market, rapid collapses in value. The chart below shows that since the 1970s gold has collapsed quite a few times:

That feature makes it an unpalatable investment for most people, including yours truly. Perhaps if gold hadn't run up so high, then spooked investors so much with its 30% decline in 2013, it would be more attractive right now. Certain things do work in gold's favor to support the price, like buyers of jewelry and industrial buyers that buy gold regardless of price, but generally speaking, if fear takes hold in the investor gold market, there's nothing preventing gold from dropping like the mineral that it is. Seeing as there are other options for portfolio protection out there, I prefer to wait.

But what about the coming economic collapse?

I feel as though I have to nod to this - gold will, in the event of a widespread nuclear war, meteor strike, super volcano, or climate change Armageddon, retain some sort of monetary value where most other debts, stocks, etc. will be wiped clean. However, if such a thing were to happen, gold would have little value anyway, because it requires some basic rule of law and social stability to function as a currency. Immediately following any economic collapse scenario, food and guns would be the most valuable commodities.

But if we all ended up living in a post-apocalyptic Kevin Costner movie, and you had hoarded gold while the remnants of society began to rebuild, then history would pat you on the back for being prudent and you'd end up the richest man in your village. However, something about planning for the future-after-apocalypse is just silly. Buy a gun, stockpile some emergency food, and then invest in the stock market and hope you don't have to use it. In the long run, the pessimists may be proven right, but in the meantime, the world is inherited by the optimists.

Gold is a decent tactical position in a portfolio - but it's not suitable as a core holding, and right now is probably not the best time to own it. For those interested in gold, ETFs such as GLD, IAU, SGOL are the cheapest ways to own.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.