Advisers look past the glitter, debate gold's value as a long-term investment

Advisers who beefed up or held onto allocations to gold over the past four months are likely seeing the benefits in client portfolios. But even that extreme test doesn’t solve the age-old riddle of whether gold is a short-term play, a long-term allocation, or even an asset that belongs anywhere near a responsible investment strategy.

“Gold is an all-weather asset but people have a tendency to only appreciate the diversification benefits in down markets, which is why gold gets its reputation for reducing risk is down markets,” said Ryan Giannotto, director of research at GraniteShares, an ETF provider whose funds include GraniteShares Gold Trust (BAR).

Even though Giannotto clearly has a dog in the fight, he is riding high on the reality that gold has been shining brightly with a year-to-date gain of 13%, while the S&P 500 Index experienced an extremely volatile ride down 10.8%.

Giannotto and other so-called gold bugs argue that the recent outperformance of gold relative to the broader financial markets is proof that gold should be a full-time piece of any diversified portfolio.

A GraniteShares analysis of the 15-year period through December 2018 shows that an allocation of just 5% to gold improved the risk-adjusted performance of a standard 60-40 portfolio of stocks and bonds 79% of the time.

The research found that optimal risk-adjusted performance, as measured by the Sharpe ratio, can be achieved with a 60% allocation to equities, 5% to bonds, and 35% to gold.

The research focused on the measurement of relative risk in portfolios.

For example, over the 15-year period, which GraniteShares argues includes the full range of market cycles, a portfolio with a 60% allocation to the S&P 500 Index and a 40% allocation to the Bloomberg Aggregate Bond Index produced a 10% annualized gain with 10.5% annualized risk.

By adjusting the fixed-income weighting down to 25% and adding a 15% weighting in gold, the annualized return climbs to nearly 11.2% with annualized risk of 11%.

But increasing the gold allocation to 35% and cutting bonds down to 5% over the period, the annualized return is 12.8% with an annualized risk of 12.5%.

“Now we have a real reason to see materially higher gold prices, because Fed policy has made bonds effectively worthless,” Giannotto said. “Bonds are facing double jeopardy right now of no income and the threat of inflation, while gold is non-correlated and the Fed can’t manipulate it and can’t buy it.”

Dennis Nolte, vice president at Seacoast Investment Services, also believes gold should be a permanent fixture in most diversified portfolios.

“Gold acts as a currency, not a commodity, which is good since oil continues to show a deflationary trend, which is where gold shines,” he said. “Deflation, not inflation, is the current worry. The market is pricing negative interest rates in the U.S., so gold will be a good holding.”
While advisers, economists and various market watchers speculate on where the economy is heading, those with allocations to gold have been happy so far this year.

Chris Chen, wealth strategist at Insight Financial Strategists, started adding gold to client portfolios in January, back when the stock market was still climbing toward the late February peak and most of the world was not yet focused on what would become a global COVID-19 pandemic.

“Historically gold has been a safe haven asset in times of crisis, and if we believe we are going to continue to have a volatile market, a small allocation to gold probably makes sense,” he said.

The fact that the stock market has gained nearly 30% off the March 23 low doesn’t give Chen any special sense of calm against the backdrop of a looming economic recession.

 “The market has been on a tear in April, but the fundamentals will probably disappoint again in coming months, so I think gold is a prudent hedge right now,” he said. “At some point we might get out of gold, but my clients have to remain invested and this is the kind of environment where you want some gold.”

For some advisers, the diversification benefits of gold are still outweighed by the analytical roadblocks that have always dogged the precious metal.

Most of the debate centers around whether gold is a currency, a commodity, or just a heavy, shiny metal that can be used to make expensive jewelry.

“Gold has doubled in price since 1980, while the Dow is up 30-fold over that period, not counting dividends, so why should I buy gold?” said Larry Luxenberg, principal at Lexington Avenue Capital Management.

“I’m not a fan of investing in any commodities because I don’t want to buy the physical commodity, the ETF, or the mining shares, because they all have problems,” he said. “For short periods of time gold or any commodity can work, but the market timing is so difficult, and you have to be very lucky. Nobody knew the market was going to go down at the end of February and in a two-week stretch have seven of the 20 most volatile days in the market’s history. I don’t believe in having any commodities as a diversifier. If you own broadly diversified mutual funds or ETFs you’re picking up some indirect commodity exposure.”

The unique nature of gold as a non-income producing asset is where financial advisers have to navigate between the physical metal and the associated mining stocks, said Paul Schatz, president of Heritage Capital.

“The stocks are more volatile and aggressive, but usually more rewarding,” he said.

As a trading strategy, Schatz believes the physical metal and the stocks both “look tired.”

“Retail investors have flowed into gold ETFs, and I think they have some pain in front of them,” he said. “But whatever pullback we see, our strategy is buying weakness because gold is in a confirmed bull market with new highs coming on the way.”

Meanwhile, Rob Greenman, lead adviser and partner at Vista Capital Partners, can’t get beyond the inanimate object thing when it comes to gold.

“Gold doesn’t produce any goods or services, there are no profits, no earnings or income, it’s future rise or fall in price is purely based on the speculation of what a future buyer is willing to pay,” he said. “It probably could be a temporary diversifier, but you’re just taking a gamble.”

Such naysaying is missing the bigger picture, according to Joseph Cavatoni, head of the World Gold Council Americas, which has been recommending increased allocations to gold for more than a year.

Cavatoni said the two fundamental drivers behind the price of gold are economic expansion and market uncertainty.

“When people get rich, they buy more jewelry,” he said. “And on the opposite side, people buy gold when there is market uncertainty.”
Cavatoni said the World Gold Council’s outlook for gold a year ago was based on increased geopolitical and financial market risks.

“That was prior to all of what we’re looking at with COVID-19,” he said. “The journey we’ve been on has been amplified substantially.”