In the Entrepreneurs Organization, lovingly known as a support group for entrepreneurs, there is a saying to watch out for shiny objects. This refers to a characteristic of entrepreneurs that lose focus as soon as they start working on a new and exciting project. This kind of business owner is also known as a gold bug.
There is no doubt that gold is a currency. It has been that way for hundreds of years. Besides being a currency, gold is also used in speculation and diversifying one’s portfolio.
As in all markets, the value is in the eye of the beholder. At any one time, there is a buyer and a seller with each investment. This is what makes a market operate. The question is what is gold best used for – investing, as a hedge against inflation or speculation?
That is for you to decide. But with gold beginning to get its luster back, we wanted to review our previous post on gold and provide comments from an industry veteran about how gold is looked at from a technical basis and how the largest hedge fund manager uses gold in his own portfolios.
Previous Post
In our last gold-related post, titled Market Mini | Gold: An Investment Ally or Unreliable, Campbell R. Harvey, a J. Paul Sticht Professor in International Business from Duke University and author of The Truth about Gold: Why It Should (or Should Not) Be Part of Your Asset Allocation Strategy, looked at the historical perspective of gold as a hedge against hyperinflation, inflation, safe haven and currency hedge. He found no conclusive evidence in history for investing in gold based on the usual reasons people invest. The greatest opportunity he saw in gold was with momentum investments and maybe a guard against hyperinflation.
Comment from Industry Veteran
Miguel Perez-Santalla, Vice President of Business Development for the U.S. branch of BullionVault.com, commented on the article about its place in portfolios and on momentum investing.
On gold’s place in a portfolio, he said:
Gold is the only insurance plan in the case of failure of the financial system. Many people wish they owned some percentage of gold when the global economy began to crumble in 2006 and on.
On momentum investing in gold, he said:
Investing when it is going up is like buying life insurance when you find out you have a grave illness. Of course, what you really want is to trade gold as a speculator and not as an investor for future value.
Technical Basis
I wanted to expand on the analysis of gold as an investment with research by Tom McClellan, editor of The McClellan Market Report. McClellan looked at two trends in gold prices:
- Long term-trend of eight years
- Short-term trend of 13.5 months
In both cases, he correlated the cycles to two unlikely events – rainfall in Tacoma, Washington and the cycle of the moon.
Gold prices peaked in 2011 and fell dramatically in December 2013. Since late 2013, gold has done extremely well and had already given back over a third of the returns by late March of this year.
As McClellan observed:
Gold prices tend to go up and down with the rainfall in Tacoma, Wash. Why would this be? Truthfully, I have no idea. All I know is what I see in the chart about how the two data series seem to correlate. I can think of no fundamental reason why the two should ever be correlated, but they remain so despite my lack of insight.
McClellan found that there is a persistent pattern of low amounts of rainfall and drops in gold prices about every eight years.
The price of gold has bottomed out in 1985, 1993, 2000 and 2008. Based on this series of years, McClellan believes we can look forward to a low in both gold prices and rainfall amounts in 2016. Consequently, the recent rise in the price of gold may just be a surge before a decline occurs in 2016.
Further, McClellan observed a price cycle for gold lasting 13 ½ months that was posted on August 22, 2013. If we were to continue the graph through today, we would see a double bottom that occurred in August and December of 2013, similar to the cycle low that split in two in 2012. Here’s what McClellan has to say:
Why does this cycle exist? That is not a question for which I have a good answer. But I can say that it has been around for a really long time. Here is a long-term flashback chart showing how this cycle behaved between 1996 and 2008.
Trends can last for years on end and disappear as quickly as they emerge. Whether you use technical analysis or look at other fundamental analysis as Campbell R. Harvey does, it is best to understand the reason why you have gold in your portfolio.
Hedge Fund Manager Uses Gold
For the last perspective, Ray Dalio, founder of the largest hedge fund in the United States, places gold in his portfolio because he does not know what will happen and therefore believes there needs to be a balance of risk reward with other assets, such as stocks, bonds and TIPS to have consistent returns.
Dalio explains that all asset classes have environmental biases. They do well in certain environments and poorly in others.
Dalio and his team at Bridgewater Associates, LP took a look at the world on four different occasions: with rising and falling inflation, and rising and falling growth of the economy. Gold and commodities in general play a part in the portfolio. Twenty five percent of the portfolio should be put into investments that increase for growth in the economy and 25% should be invested for inflation. In both cases, 25% is not the percentage of dollars invested, but rather the percentage of risk allocation. Because stocks and gold have a larger unit of risk for each dollar invested, Bridgewater borrows money or invests in options on bonds to increase the exposure of bonds in the portfolio so that they equal out the risk exposure between the different investments.
Go for Gold?
It may be a good idea to include gold in a portfolio to balance other moves in the market, as Miguel Perez-Santalla and Ray Dalio believe. It may also be popular to add to gold when momentum in the commodity starts as Campbell R. Harvey and Tom McClellan find. The bottom line is your perspective on gold and how you use it in your portfolio is for you to decide.