Should you invest in gold?


I was interested to watch this YouTube video produced by ETF manager, BetaShares which compared the differing views of Warren Buffett and billionaire fund manager, Ray Dalio.

Both men have been some of the most successful investors over the past 50+ years, yet they have opposing views regarding investing in gold, which I find very interesting.

How well has gold done?

As depicted in the chart below, the (USD) gold price has appreciated by 7.66% p.a. since 1970. However, between 1980 and mid-2002, the price of gold fell by an average of 4% p.a. Between mid-2002 and mid-2011, the price of gold appreciated at an extraordinary rate of over 20% p.a. Since then, gold is relatively unchanged i.e., its currently trading at 2011 levels, so there’s been no (nominal) growth over the past 11 years.

Gold price

Whilst the very long-term returns (i.e., 5 decades) are quite healthy, it’s clear that gold can experience (10 to 20 year) cycles where it can deliver poor returns.

The upshot is that if you are going to invest in gold, you better get your timing right (buy after a long period of poor returns e.g., 2002) and/or be prepared to hold it for a very, very long time.

Why do people invest in gold?

Firstly, gold is seen as a defensive investment. That is, when investors become concerned about the future returns that growth assets (shares and property) might offer, they seek safer investments, one of which is gold. It is seen as a way of preserving wealth because gold is a scarce metal and as such, is expected to retain its value (as demand always exceeds tight/finite supply).

Secondly, gold can be seen as a better storage of value than currency, as the value of a country’s currency can be volatile. There are many factors that can affect the value of a country’s currency including interest rates, economic stability, inflation rate, current account balance, monetary policy such as quantitative easing and so forth.

Why aren’t I attracted to investing in gold?

Firstly, gold doesn’t produce any income, unlike other defensive assets such as bonds. Therefore, to generate an investment return, the value of gold must continue to rise over time. However, there have been long periods of time when this hasn’t happened e.g., price of gold fell 60% between 1980 and 2002 (i.e., fell 4% p.a.).

Secondly, there is only one way that the value of gold can rise and that is when demand exceeds supply. Approximately 80% of gold is used for jewellery. Therefore, if you invest in gold, you are taking a strong position that demand for jewellery will continue to rise. Whilst that’s probably not a risky bet, I agree with Mr Buffett. That is, gold is not a productive asset unlike a company (stock). Companies have lots of ways they can generate value for shareholders.

What are some better defensive investments?

If investors are concerned about future returns in equity markets and desire lower risk investments, there are a few defensive investment options they can consider.  

The most common defensive investments are bonds. Bonds tend to have a negative correlation with shares i.e., when shares fall in value, bonds tend to rise in value (except for only 3 years out of the past 100 being 1931, 1969 and 2022 when the value of bonds and shares fell at the same time). The higher the quality the bond, the safer the investment is. Therefore, AAA rated government bonds are the most defensive options.

Some shares can be more defensive than others. For example, consumer staples, health care, energy and utilities tend to be defensive sectors. Also, robust higher dividend yielding stocks are seen as more defensive too, as a lot of their return is delivered via income (dividends) and less reliant on capital growth.

I believe you should not invest defensively

It is my view that adjusting your asset allocation to be more defensive simply because you are concerned about short term economic issues (e.g., potential for a recession) is the wrong approach.

I believe that you should adopt long-term asset allocation that is aligned to your risk profile and stick with it (unless your risk profile changes, of course). However, it is important to adjust your investment methodologies depending on the risks and opportunities that may be present.

For example, currently the key risk is a global recession. To accommodate that risk, I prefer to invest using a low-cost, rules evidencebased value and quality factor approach.

Value involves investing in an index of stocks that represent good value for money (e.g., trading at low price-to-book or price-to-earnings ratios). Quality is an index of companies that meet certain quality metrics such as a strong balance sheet, stable profitability and cash flow, consistent dividends and so on.

The advantage of this approach is that you’re not taking a big bet on your expectations, as they could turn out to be incorrect e.g., a recession may not occur, or it may end up being a shallow recession. However, you are protecting your downside by selecting appropriate methodologies to reduce your investment risk and arguably exposing your portfolio to potentially higher returns when a recovery occurs.

Gold makes a nice gift (jewellery), but not an investment

It is possible that gold might be an attractive short-term investment e.g., if the price fell substantially or after a long period of price declines. But you should know by now that I play the long game. I don’t get distracted by short term investments because they rarely create long-term value.

Therefore, I doubt I would ever be interested investing in gold. In the long run, bonds and equities will produce higher returns.