So says Chris Philips, senior analyst in Vanguard Investment Strategy Group in edited excerpts from an article* entitled A better safe haven than gold.
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The article goes on to say in further edited excerpts:
“During periods of market stress for equities, the asset that has performed most consistently across time is U.S. Treasuries.” Even if clients are considering the asset for diversification purposes, Philips cautions investors from jumping in headfirst. “Investing in gold comes with significant risks that should be weighed carefully.”
Risks of gold as an investment:
- The asset class has shown itself prone to boom-bust cycles throughout history. Its volatility since 1968 has exceeded that of stocks, at 20% versus 16%.
- In the last half century, gold experienced a bear market that lasted nearly 21 years. The price of gold went from a high of $670 a troy ounce in mid-1980 to $258 by early 2001, losing nearly two-thirds of its value—even before accounting for inflation. That could be enough to tarnish some of its luster, especially among clients looking for safety…
- Investors tend to pile in toward highs and sell on lows.
- According to Morningstar, Inc., investors in one of the largest gold ETFs lagged the return of that ETF by more than an average of 3 percentage points annually since the end of 1994 (11.86% versus 8.66%), largely because of the timing of investor cash flows. “The reality of performance chasing calls into question the suitability of such a volatile asset in clients’ portfolios,” suggests Philips.
- There’s little if any evidence to support the claim that gold is a good hedge against inflation.
- The chart below plots historical gold prices against prices adjusted for today’s purchasing power. As the blue line indicates, the value of gold has not kept up with inflation.
- “The value of gold is subject to the whims of the marketplace, driven more by global supply and demand than inflation,” explains Philips, making it much like other commodities. “Using gold to hedge inflation may or may not be effective. The price movement over the past decade makes that point.” During a period when U.S. inflation was well contained, the price per troy ounce shot from $400 in 2005 to nearly $2,000 in 2012, and then plunged below $1,200 in 2013, bouncing back above $1,300 recently.
U.S. Treasuries are an enduring diversifier
- Despite the rising interest rate environment, Treasuries remain among the best safe-haven assets.
- During the global financial crisis, while gold prices spiked in volatility, falling nearly 30% from peak to trough in 2008, Treasuries were one of the few asset classes that provided downside protection through the uncertainty.
- “Correlations tend to increase among risky assets during periods of extreme market stress, and gold’s record as a safe haven has not been as consistent,” points out Philips.
- The high degree of certainty of cash flow and return of principal is what makes Treasuries a good safe-haven asset. That’s peace of mind that is worth something, especially during times of extreme market stress.
- The flight to quality in January reinforces that point. As equities dropped, Treasury prices moved higher, offsetting stock losses and dampening portfolio volatility.
- “The role of high-quality bonds as a diversifier, especially during sharp equity market declines, remains intact regardless of yields and justifies their inclusion in balanced portfolios,” says Philips. (High-quality bonds include U.S. Treasuries and other fixed income securities with a credit rating of Baa3 or higher by Moody’s or a credit rating of BBB- or higher by Standard & Poor’s or Fitch.)
The trade-offs inherent in gold
…Even as interest rates rise, what ultimately matters most for risk-averse clients is the return of their total portfolio.
- Over the long term, Vanguard expects bonds to continue to reduce the risk of loss for balanced investors. Accordingly, greater economic uncertainty argues for holding more bonds, not less.
- By contrast, an investment in gold could result in big gains, but based on its volatile history, a bust isn’t out of the realm of possibility either.
- Clients who are comfortable with gold’s unique risks should view an investment in the context of a well-diversified portfolio, rather than as a concentrated position.