Gold: Hedging For WHAT, Exactly?

|
Includes: GLD, GTU, IAU, OUNZ, PHYS, QGLDX, SGOL
by: Charles Lewis Sizemore, CFA

3591749965_7d156e86ac_o

After looking dull for years, gold is finally sparkling again. With the market in convulsions and Fed Chair Janet Yellen broaching the possibility of negative interest rates, the yellow metal is up about 17% in 2016.

Hey, I get it. People are scared. And justifiably so. Frankly, I'm a little scared about where all of this is going. But before you run out and fill up the truck of your car with precious metals (and perhaps canned goods and ammo) let's look at gold with a cold, analytical eye. Gold could go a little higher from here. It certainly has momentum at the moment. But if you're looking for a true crisis hedge, gold isn't it.

Gold is less of an investment and more of an emotional ideology. Investors, and male investors in particular, have an odd way of developing feelings for the assets they buy. Just as sailors have for centuries given their ships a woman's name, many men get possessive about their stocks. If you insult it, you might as well be insulting his wife or mother. But with gold, the attachment goes even deeper. Being a "gold bug" is not just a matter of passionately believing in the investment merits of gold. It is an identity and one that exhibits many of the characteristics of a radical political movement or even a religious cult. (There is a fundamental belief: Gold is the "one true store of value" or the "one true currency" and all imposters are heretical.)

Don't be that guy. No one wants to be that guy. He's a buzzkill at parties and way too intense.

But I digress.

Let's strip away all ideology and try to look at gold fairly on its own merits. I would argue that the "barbarous relic" does indeed have its uses but that it's still the wrong hedging assets to own in this market. Let's break down the arguments in favor of gold:

#1. Gold is an inflation hedge. Okay, I don't necessarily argue with this point. Over the years, gold has indeed proven to be a decent inflation hedge. Now, I might argue that real estate is a superior inflation hedge and also has the additional benefit of paying current cash flow in the form of rental income. But I'll go ahead and cede this point to the gold bugs.

The big problem here is that an inflation hedge is only valuable when you actually have inflation. And right now, inflation is in short supply. In fact, with crude oil prices still looking wobbly, consumer price inflation is under 1%.

A lot of Americans have been fearing that rampant inflation is right around the corner due to excessively loose monetary policy. Well, the logic seems straightforward enough. But you could have made the same arguments about Japan at any point over the past 20 years, and you would have been wrong. All the monetary easing in the world will have little impact on inflation at a time of aging demographics and hobbled banks, which is where we are today. And in Japan, they're still fighting outright deflation.

So yes, if you're buying gold as an inflation hedge, you are effectively buying expensive insurance for a risk you don't need to insure.

#2. Gold is a crisis hedge. I'm a little more sympathetic to this view. I'm a big believer in having a true zero hedge in the event the world really did go to hell in a hand basket. So yes, having a little gold bullion buried in the backyard, along with a good supply of shotgun shells, isn't the worst idea. (I'm from Texas. We're all nuts.)

But as far as safeguarding a portfolio, I'm less convinced of gold's value as a crisis hedge. When the world gets truly shaky, investors tend to flock to the U.S. dollar and to U.S. government bonds rather than to gold. In fact, the price of gold actually fell during the 2008 meltdown, and I would expect more of the same in the event of another global crisis.

So, by all means, keep a few gold coins stashed away somewhere safe… just in case. But don't overload your investment portfolio with the stuff.

#3. Gold is a store of value. Sure, gold is a store of value. Sometimes. But there can be long stretches of time when it isn't. Throughout the 20 years of the 1980s and 1990s, gold lost value almost every year. And the perception of gold's value is purely subjective. Gold pays no interest or dividends and has little in the way of commodity value outside of modest use in electronics and dentistry. So assigning a value to gold is just about impossible.

My advice? If you are hell bent on owning hard assets, choose something that generates income, whether it is a rental house, a commercial building or even a piece of farmland. In a deflationary economy, none of these will have much in the way of price appreciation. But you'll at least collect rental income along the way and you're a lot less likely to have your judgment impaired by the politics and ideology that tend to swirl around gold.

This piece first appeared on Economy & Markets.

Photo credit: Bullion Vault

This article first appeared on Sizemore Insights as Gold: Hedging for WHAT, Exactly?

Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results.

Original Post