Gold has developed many diehard supporters over the past 10 or 12 years, due in large part to GLD and the other ETFs and funds that made it easy make gold a part of your portfolio. In fact, there has been an explosion in gold funds after State Street introduced GLD. According to the Investment Company Institute's 2012 fact book, money going into commodity ETFs grew from $1 billion in 2001 to over $109 billion in 2011, and it has been going up from there. People buy gold for a few reasons. Most people I talk to think of it as an alternative currency, the ultimate hard currency, to hedge exposure to all fiat currencies, especially now that euros, dollars and yen all look increasing weak. People have used gold as a currency for thousands of years and despite the attempts of alchemists shysters to debase it, gold has proven difficult to manipulate. For those reasons people also buy gold as an inflation hedge or simply a safe-haven store of value in uncertain times.
At the risk of incurring the wrath of gold's many diehard fans, I offer here five reasons to avoid gold in your portfolio or even to sell it short. First, gold behaves more like a commodity than a currency. Commodities and currencies are also correlated, so it often looks like a currency, but probably not at the time you would most want it to. A simple regression over the past three years of the dollar index on gold gives us an R-squared of 14.7%. For same period, regressing the Powershares DB Commodity Index Tracking ETF (DBC), we get an R-squared of 32.1%. This means that when assets are selling off, even dollar ones, gold likely goes down with them as well. That's not what you want in a hedge.
Second, people who are less worried about the short term risk-off trades and more worried about keeping a store of value may not be getting what they are paying for either. Gold bulls have often referred to some variation of the chart below to show that gold still has room to go before it gets to the high price from 1980 in real terms. But the chart also demonstrates that gold is a terrible store of value and a terrible inflation hedge. If it takes 32 years for gold to recover its "intrinsic" value, we might not live long enough to see it again.
(Click to enlarge) source: Bloomberg
Third, gold as the "Armageddon" trade, for when everything else fails, makes little sense. I have little insight into what Armageddon might look like, but if Armageddon means things like hyperinflation, high volatility, stock market collapse, political upheaval and economic depression, I would avoid gold for the reasons already mentioned. The idea of keeping wealth in tangible assets is valid, but gold may be worth a lot less with still no guarantee that it will be accepted at your local grocery store. It was used as currency historically, but unless you are buying a tanker full of oil from Iran, it may not buy what you want. If Armageddon means something even worse, I imagine that keeping a small farm house stocked with food, water, supplies and weapons might be the way go.
Fourth, gold is popular trade now, a fad one might say, and it will lose favor again. It is popular because of fear and because of the new funds that have allowed the retail investor to participate. That participation alone created the surge we have seen in the past decade, which started well before the hint of any financial crisis. Kudos to everyone who caught that swing. But be wary of piling into an investment appears to be on the last leg of a bull market. Fear will subside; the unpopular sectors will rise again, and the most popular ones will fall. There could always be another leg to the upside, but remember that lot of people were buying in 1980 too. From a technical perspective, the daily chart below looks like it has already turned bearish, and will look more so if the support around 1525 gets broken. The tops are trending down and we are below the 200 and 300 day moving averages (yellow and purple lines).
(Click to enlarge) source: Bloomberg
Fifth, and last, there are many better things in which to invest our hard-earned money. For the record, there is nothing inherently wrong with holding a little gold. Since gold trades like other commodities, include it in your commodity allocation for the little bit extra that it may diversify your commodities. But leave most of the room in your portfolio for the stocks, the real estate, all the other assets classes that go up with inflation plus some. If, on the other hand, you would really like to make a more pure inflation bet, consider a TIPS fund such as the SPDR Barclays Capital TIPS ETF (IPE). TIPS were designed specifically to hedge inflation and are linked directly to the CPI index. TIPS have a negative yield now, but gold investors would expect that since any true store of value has a negative real yield after fees.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am short gold futures on the CME.
