As the market (SPY, QQQ, DIA) has entered "panic mode" due to Brexit, investors have been piling into safe haven assets such as treasuries (NYSEARCA:IEF) and gold (NYSEARCA:GLD). Bonds backed by the world's most powerful country are no doubt safe. There is a guarantee of principal, plus a little interest. However, there is no consensus regarding gold. For example, Buffett believes that gold has no intrinsic value, saying:
Gold has done very badly [as an investment] in the past and I see no reason why it will work well in the future. All that happens is that it is taken out of the ground in South Africa and put back in the ground in Fort Knox.
On the other hand, we have the famous hedge fund manager Stanley Druckenmiller, who treats gold as a form of currency, implying that it does have value. During the Sohn Conference in May, he said the following regarding gold: "Some regard it as a metal, we regard it as a currency and it remains our largest currency allocation."
Those are two legendary investors with diverging views. Who is right?
I believe that both views can be correct depending on the type of analysis applied, though Druckenmiller's view is slightly flawed. From a value investing perspective, gold has no intrinsic value if you just hold it in a vault. However, we cannot deny that gold is readily fungible with cash (i.e. it is a currency), which is why central banks are some of the largest buyers. However, gold isn't backed by the purchasing power of any specific currency nor is there interest rate parity to govern its relationship with other currencies. While no reconciliation between the two views is necessary, this does have serious implication for gold's "safe haven" status.
Safe haven assets are supposed to protect your principal no matter how the market behaves. If you buy 10 year Treasury notes, you know that you will get your principal back regardless of where S&P 500 ends up. Gold provides no such protection. As mentioned earlier, gold has no intrinsic value, making it impossible to value in the traditional sense (other than asset value, which would be the spot price). This means that gold at $100 is as fairly valued as gold at $1000 from a value investing perspective. Even though we can call it a currency, it is literally worth what the market is willing to pay for it at any particular time as there is no underlying macro variable that governs its price.
So gold doesn't have intrinsic value, isn't backed by any fundamental macro variables, yet people still see it as a safe haven asset? Remember, a safe haven asset must store value regardless of market conditions. Clearly gold does not fit the bill.
Proper Way To View Gold
However, despite the above contradiction, I believe that gold can still have its place in your portfolio. Instead of being treated as a safe haven asset, gold should be thought of as a short-term hedging instrument. We know that investors tend to buy gold when the market performs poorly, which means that gold moves in the opposite direction of the market in the short-term. For example, as the market plunged by 3.6% on Friday, gold gained 5%. But this correlation does not hold up over the long-run:
In the chart above we can see that both S&P 500 and gold has risen significantly over the past 25 years, implying positive correlation over the long-term. We can also see that there are periods when gold provided no downside protection even in the short-term, illustrating the problem of contagion, or colloquially known as "all correlations go to one during a crisis."
Gold has no intrinsic value and hence cannot be viewed as a safe haven asset. However, we know that investors tend to chase after gold if the market performs poorly over the short-term. On that basis, an adventurous investor may choose to buy gold as a short-term hedge; but don't be surprised if gold depreciates during a financial meltdown due to the effects of contagion. Finally, note that gold and the stock market has positive correlation over the long-term, hence gold must be traded frequently to maximize its hedging effectiveness.
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