In my continual efforts to challenge investment advisors and journalists about the need to diversify with gold, a pleasant surprise developed today…..an advisor responded!
Even though the title of his article is misleading, Larry Swedroe, principal and the director of research for Buckingham Asset Management and BAM Advisor Services, did respond to my comments about his CBS Money Watch article; “Don’t Believe the Hype About Gold.”
In the following exchange, Larry Swedroe did admit that gold, should be included in a diversified portfolio although he does recommend a couple other options as possible alternatives (which could be a separate debate, but this post will be long enough as is).
His article is below and our discourse follows. It is both civil and well reasoned from both sides of the debate about gold as an investment.
Don’t Believe the Hype About Gold
by Larry Swedroe
Driving a car based on what you see in their rear view mirror is not a good strategy. And neither is investing based on yesterday’s returns. Falling prey to “recency” — the tendency to give too much weight to recent experience – leads many to buy yesterday’s winners high and sell yesterday’s losers low. And buying high and selling low is not exactly a prescription for investment success.
The latest example of this is gold. This interest is based on the fact that the price of gold has risen more than $700 since 2002. And there’s the usual media hype because that’s where the action is. Before you decide to allocate some of your portfolio to gold, consider the following:
- In January 1980, the price of gold hit $850, an increase of over $700 from its price just five years earlier. (Sound familiar?)
- The media was filled with headlines eerily similar to today’s — fears of inflation, a falling dollar, huge budget deficits and foreign policy problems.
By June 1982, the price of gold had fallen to less than $300 an ounce. And more than 20 years later, in January 2002, it was still trading at less than $300. Keep in mind that these stagnant returns don’t consider the direct costs of investing in gold, let alone the lost returns you could have been earning had by investing in either equities or bonds.
One can only wonder how many investors would’ve stayed the course — waiting patiently, persistently rebalancing and pouring more money into gold to maintain its weighting in the portfolio — after watching it drop $700 and then do nothing for more than 20 years.
Spanish philosopher George Santayana warned: “Those who cannot remember the past are condemned to repeat it.” If you’re not prepared for another such spell, you shouldn’t invest in gold. The historical record is that gold experiences long periods of poor returns followed by very short, unpredictable bursts of spectacular returns.
Here are some important facts to consider. Over the very long term, gold has provided virtually no real return. However, the attraction of gold is not a high expected real return, but that it has had a negative correlation to equities — it has a tendency to do well when stocks are doing poorly. You certainly don’t need gold to hedge inflation. TIPS are a far superior hedge of inflation, as are short-term Treasury bills. Gold does hedge some (but not all) of the risks of equity investing. It can be a haven in times of crisis when investors are seeking safety. However, you only get the benefit of negative correlation if you have the discipline to rebalance. And that can be a very tough task as the historical evidence demonstrates.
If you’re going to invest in gold, you should consider this advice from Charles Ellis: “Learn from deer hunters and fishermen who know the importance of ‘being there’ and using patient persistence — so they are there when opportunity knocks.”
Our Exchange:
DougDiggerEberhardt
09/14/09 | Report as spam
RE: Don’t Believe the Hype About Gold
Larry, I’d like you to consider that the dynamic for gold has changed sine the year 2000 as the dynamic for the U.S. dollar has also changed since that time.
There is now more competition to the dollar than there was before 2000 (like during your 80’s example) with the introduction of the EURO and since, the introduction of ETF’s allowing more to invest in gold as insurance from a falling dollar.
Before 2000 there wasn’t any real competition to the dollar and until that time, the dollar was supreme and had been since 1971 when Nixon took us off the gold standard. That’s when Nixon basically told the world, take our dollars “as is.”
The dollar index is currently hovering around the 76-78 range. When that 72 mark of last March is taken out, one better have the insurance that only gold can offer. Breaking 72 on the index puts us in uncharted territory that even TIPS won’t counteract (which is a whole separate area of discussion about how CPI has changed over the years). It also doesn’t mean that at present, the dollar can’t bounce higher and gold fall. But year over year, gold is still on pace for its 9th straight up year. No other asset class can claim that.
Again, the dollar is the key. Just look at the gold/USD chart since 2000 and you’ll see what I mean.
I wrote an article about this decoupling with gold and the dollar after 2000 with the intro of the EURO and a few others about how financial advisors don’t understand how gold needs to be a part of everyone’s portfolio. One can find these articles by clicking the “gold” tab on my blog: http://fedupbook.com/blog.
You’ll also see a white paper I wrote about investing in gold there.
Disclosure: I don’t sell gold. I just write about it.
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larry swedroe
09/15/09 | Report as spam
RE: Don’t Believe the Hype About Gold
Doug
The four most dangerous words for investors are “this time its different.” IMO there is nothing really different (such as your claim there is more competition).
Another of my favorite expressions is the only thing you don’t know about investing is the investment history you don’t know.
Which is why I pointed out that we had “been there, done that” with gold before.
BTW–another myth surrounding the dollar is that if it loses its status as reserve currency that is really bad for stocks. Well the UK lost its status as the reserve currency and over the last 55 years UK stocks have outperformed US stocks. So much for that myth.
As I said, gold does hedge some of the economic and political risks that equity and bond investors face. But the only way investors have been rewarded for doing so is that they have had to show the patience and discipline to wait 20 or 30 years and then get the benefit–and that means rebalancing along the way, buying AFTER if goes down and selling AFTER it has gone up. Otherwise the returns have been miserable.
The same issues apply to investments in collateralized commodities futures (CCF) in general (my preference). You have to have the discipline to rebalance and stay the course, absorbing long periods of poor returns. In fact, you should be rooting for poor returns because the ONLY reason to buy gold or CCF is as portfolio insurance. And no one wants to collect on the insurance. They want the rest of their portfolio to be doing really well and are willing to see their “insurance premium” go to waste.
My experience is that the vast majority of investors get this dead wrong.They only buy after the great returns have been realized and then sell after they poor returns have been realized.
My crystal ball is always cloudy. And that is why I own a small allocation to the PIMCO Commodities Fund (PCRIX), which is my preferred choice. I wrote the blog so that investors could make an informed decision about investing in gold BEFORE they reacted to the noise. At least forewarned is forearmed.
For those interested, my book, The Only Guide to Alternative Investments You’ll Ever Need, has chapters on investing in CCF and precious metals equity (an alternative to gold).
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DougDiggerEberhardt
09/15/09 | Report as spam
RE: Don’t Believe the Hype About Gold
Larry, I appreciate the discourse.
I do take issue with the “this time its different” statement as being “four most dangerous words for investors.” Allow me to explain.
Up until 1971, the price of gold was fixed and Americans were not allowed to own more than $100 of gold. It wasn’t until 1975 when U.S. citizens could actually purchase gold in larger quantities. So technically, in just five years from that date, gold soared to its then all-time high.
Being that there was no competition to the dollar at that time, Fed Chairman Volcker stepped in and raised interest rates to where the dollar, which still had the U.S. production for the world backing it, became more attractive than gold. Today, that story cannot repeat should the dollar become less attractive.
The dollar has 38 short years of existence without gold backing. In that time we’ve had a Savings and Loan crisis and our current banking crisis, coupled with Central Bank sales of gold keeping the U.S.dollar price at bay (there’s a reason why Central Banks have so much gold…to give the illusion that the gold actually backs the currencies of the world). During the S&L crisis, the dollar was still king of the world.
But since 2000, this dynamic has changed with the intro of the EURO and since, many ETFs around the world that allow investors to buy gold.
You say that an investor has to wait 20-30 years for gold to go higher. Yes, it had “been there and done that” once. I submit that there there was no competition to the U.S. dollar when that single occurrence happened.
You said: “the ONLY reason to buy gold or CCF is as portfolio insurance. And no one wants to collect on the insurance. They want the rest of their portfolio to be doing really well and are willing to see their “insurance premium” go to waste.”
And this I agree with. Gold should be part of everyone’s portfolio as “insurance” that no one wants to collect on. But in analyzing the economics of what our government is doing, I don’t like what I see with the last administration and this one adding trillions of new debt to the trillions of old debt. And that’s why I recommend people hold gold.
It just so happens that the returns for gold haven’t been that bad either which would have stabilized investors portfolios over the last 8.5 years.
If an investor earns 10% on their portfolio and the dollar falls 10%, they haven’t created any new wealth. That’s why I think its imperative to watch the U.S. dollar index and that 72 level. Then and only then will we see if the second time in (U.S.) history for gold to soar has arrived.
IMO, we’re still in the second and longest stage of the gold cycle.
I would hope that you think my reasoning is sound. I give you credit for responding to my first comment. Most wouldn’t. We may disagree and that’s ok too. It’s the discourse I’m after, not proof of who’s right or wrong. Time will take care of that, but you have allowed me to present my side of the discussion.
I too wrote a book about gold. http://safelybuygold.com Yes, that is a sales page, and yes, my book is expensive, but I’m just trying to help people understand gold and keep and grow their wealth…just like you. I was a financial advisor for over 20 years and left the business to write about it and take on some bigger tasks.
I like the fact you look at alternative investments, which most in America don’t. I found a link for it and will be purchasing it: http://www.amazon.com/Only-Guide-Alternative-Investments-Youll/dp/1576603105
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RE: Don’t Believe the Hype About Gold
Doug
We will agree to disagree on the this time it’s different issue. Yes we did go off the gold standard and cannot do that again. But nothing else is really different.
For example, you cite many crisis we have had recently. Well we could both cite many crisis we had before that as well, all during the period that gold did poorly. Try the S&L crisis for example, or the Asian Contagion.
And I don’t agree at all with this statement
“Being that there was no competition to the dollar at that time, Fed Chairman Volcker stepped in and raised interest rates to where the dollar, which still had the U.S. production for the world backing it, became more attractive than gold. Today, that story cannot repeat should the dollar become less attractive.”
First there was plenty of competition for the dollar. Not just gold. There was the Swiss Franc, the German Mark and Japanese yen, all considered strong currencies. BTW-I ran a FX trading room for Citicorp during the 70s and 80s, so I was there during that very period when gold ran up. And I watched people chase it, buying only after it had gone way up. They had no plan, just chasing the recent hot asset class, like betting on the “hot roller” at the dice table.
Second, there is absolutely no reason that the actions Volcker took could not be repeated IF inflation does rise again. While we can both guess at whether it will or will not, we are only guessing. There is only one person who knows what would happen and neither of us gets to talk to that person.
What we do agree on is that there may be a role for low expected returning asset classes (gold has no real expected return) in portfolios, with the attraction being non- or negative correlation to equities and nominal bonds. In other words, they can act like portfolio insurance.
We also agree I think that if you buy such insurance you will need to stay disciplined and have it as part of your long term plan, rebalancing along the way. And that from my experience is something most individual investors acting on their own have a very difficult time doing. But it is the key to success: acting like a postage stamp, sticking to your plan until you reach your financial goal.
So if you are going to buy gold, or CCF, or precious metals equities, recognize the risks, recognize that they tend to go for very long periods of very poor returns with short and unpredictable bursts of great returns, and be prepared to buy low and sell high (the reverse of what the noise of the market and your stomach will be telling you to do). In other words, it must be part of your overall plan, in writing as part of an overall investment policy statement you are prepared to adhere to over the very long term.
I hope you enjoy the book, and as I tell all readers, I am happy to answer questions you have, just email me at lswedroe@bamstl.com
Best wishes
Larry
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DougDiggerEberhardt
09/15/09 | Report as spam
RE: Don’t Believe the Hype About Gold
Larry,
As far as the competition to the U.S. dollar goes, I agree there were other currencies available, but I don’t believe mainstream investors were so much aware of the ability to put their money in those vehicles. They were just figuring out that mutual funds were a good place to put money for the most part.
Today, the size of GLD alone would make it the world’s 6th largest Central Bank (last I checked) based on its holdings, so people are definitely taking advantage of this, even last year when the price of gold was falling as there were at times, a shortage of the metal to be found.
Back in the 70s and 80s when you were running the FX trading floor for Citicorp, I would imagine you personally knew of fortunes made and lost. I knew one of those traders that made his fortune. He lived in the same building on Lake Shore Drive in Chicago with his two Rolls Royce’s (you couldn’t have just one right?).
Yes Larry, chasing it is what I would advise against too. I think what it may come down to with our differences is what stage gold is presently in. This would dictate whether the chase is now as you might claim where the last ones in get burned, or the chase of the future in that third “euphoria” stage which I believe is still forthcoming (because of current government and Fed action).
And yes, interest rate manipulation in the future with the possibility of inflation is a fine line the Fed walks.
All we can do is read what Bernanke has written in the past in his study and writings about the Great Depression. He said the mistake of the Fed then was that they didn’t inflate enough. From that, I do have to make assumptions today….
Your advice about re-balancing portfolios is spot on (pun intended, ha) and the fact you include these asset classes is to be commended. Also, from a short term “trading” perspective, gold could be topping (only as the dollar index rebounds). That $1,030 mark for gold investors is what Mt. Everest represents to a climber.
BTW, my Dad was a commodities broker (retired) on the floor at the CBOT (ADM Investors Services). He said that the number one reason commodities investors lose money is “greed.” Kind of fits in with your “dice” analogy.
Cheers and look forward to reading your book.
Doug Digger
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Larry swedroe
09/15/09 | Report as spam
RE: Don’t Believe the Hype About Gold
Doug
While I acknowledge that individual investors have more choices today, the big institutional investors and sovereign funds all had those choices available long ago and they have the largest sums that will drive prices. So still don’t agree that this time is different really.
As to Bernanke, and not tightening soon enough, he is also well aware of the mistake Greenspan made in not tightening soon enough in 2003. The press has been filled with the need for an exit strategy. Cannot imagine he is unaware. So not likely to repeat that mistake either. If bit late IMO the Fed will just likely tighten faster than normal, as it loosened faster than normal during this crisis.
The market seems to believe that scenario is the likely one. You can see that at the Philly Fed’s site, survey of professional forecasters–shows long term inflation of just 2.5%, below the long-term average of 3%.
I agree high inflation is a risk. But not a certainty, nor perhaps even likely. The costs of high inflation are recognized as very high, and best avoided.
So bottom line is on the strategy I think we agree–own TIPS for inflation hedge and then consider owning either CCF and/or Gold in a long-term plan to hedge some of the economic and geopolitical risks, rebalance and stay the course.
Best wishes
Larry
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DougDiggerEberhardt
09/15/09 | Report as spam
RE: Don’t Believe the Hype About Gold
Larry said;
“So bottom line is on the strategy I think we agree–own TIPS for inflation hedge and then consider owning either CCF and/or Gold in a long-term plan to hedge some of the economic and geopolitical risks, rebalance and stay the course.”
Yes, I do agree.
As far as the forecasters and economists who, unlike the Austrian Economists, didn’t see this coming…., not so much. The simple fact that GDP is primarily being supported by Government Spending is my reason (along with other Fed intervention). But that’s a whole separate conversation. I’ll follow your articles and chime in if you don’t mind….
I’ll definitely promote your site and this article in a forthcoming blog. You’re the first to discuss this with some actual reasoning.
It will be interesting what lies ahead and all I ask is that advisors consider gold for diversification, which you do.
Cheers!
Doug
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About Doug EberhardtDoug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534
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