Investing Fundamentals

All Things Gold

Last Updated on May 11, 2019 Last Updated on May 11, 2019
All Things Gold

Some people who are hesitant to invest in the stock market are willing to invest in gold. Why? Gold is tangible, you can see it, hold it, and keep it right in your own house (or bunker). You can buy it from some guy in a late night infomercial. You can buy it with images of the fallen Twin Towers on it. Or an American eagle.

You can’t say any of that about investing in the stock market! When you own stock, you don’t own a tangible thing. You have to deal with some slick stockbroker if you want to buy and sell it (you don’t). And stocks don’t come in a limited edition collector’s box.

LMM hasn’t discussed gold very much in the past and like a lot of you, thought it was something only Doomsday preppers were interested in so not really relevant to us or our audience. But while doing research for the Golden Butterfly episode, we learned some legitimate reasons for investing in gold and none of them are related to the zombie apocalypse that is surely coming.

Many of our listeners wanted to know more about it too, why and how to invest in gold. We got a lot of emails asking questions. You asked and we answered. This is all things gold.

The Uses of Gold

Unsurprisingly to most people, the biggest use of gold is for jewelry but the industrial use of gold in the manufacturing of electronics is a close second. Gold is a good conductor of electricity and doesn’t corrode.

A very small amount of gold is used in nearly every electronic device including cell phones, calculators, digital personal assistants, GPS systems, and even large electronics like TV sets. In fact, about $0.50 worth of gold is present in every cell phone which adds up to $500 million worth utilized each year.

Chart #1

NASA uses gold-coated polyester film in its space vehicles to reflect infrared radiation which helps to stabilize a vehicles’ core temperature. Without this film, the darker colored parts of the crafts would absorb high amounts of heat. Gold also protects astronauts. The visor on their helmets is coated in a thin layer of gold which filters out the damaging rays of the sun.

The Value of Gold

But why gold? There are lots of minerals and rocks on earth, what gives gold its value over any of them? Well, because we said so, well not us, someone a long time ago said gold was valuable and everyone just sort of went along with it. It’s no different than money. That dollar in your pocket has value because we all agree that it does.

Gold is considered a store of value.

A store of value is the function of an asset that can be saved, retrieved and exchanged at a later time, and be predictably useful when retrieved. More generally, a store of value is anything that retains purchasing power into the future.

The most common store of value in modern times has been money, currency, or a commodity like a precious metal or financial capital. The point of any store of value is risk management due to the stable demand for the underlying asset. Money is one of the best stores of value because of its liquidity, that is, it can easily be exchanged for other goods and services.

Another reason gold is considered valuable is that it’s seen as a reserve currency. A reserve currency is a stockpile of currency held by central banks and other financial bodies for investments, transactions, international debt obligations, and to influence their domestic exchange rate.

Maintaining a reserve currency limits exchange rate risk since the purchasing body doesn’t have to exchange its own currency for the current reserve currency to buy and pay for things.

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The Value of Gold as an Investment

We make jokes about Doomsday and zombies but there are legitimate reasons some experts and investors consider gold a good investment.

People seek certainty in times of uncertainty. Historically, gold has been seen as a sure thing, and the tangibility of it comes in to play as explained above, during uncertain times. Gold is considered a hedge against an uncertain market.

A hedge is a contrary position. When X goes down, Y goes up. Y is the hedge. For our purposes, X is the market and Y is gold. When the market goes down, gold tends to go up and vice versa. Recently both the market and gold have both been going up.

Why?

The uncertain times (politics, the economy, climate change, etc) we’re currently in. Gold as an investment is also a way to solve the “egg/truck” problem. Even beginning investors know that diversification reduces risk. You don’t invest all of your money in a single stock or even in a single sector, you invest in many stocks which is what you’re doing when you invest with a roboadvisor like Betterment. You’re investing in a “basket” of different stocks.

Diversification

But at some point, investing in more stocks gives diminishing returns. Why? Because your eggs are in many baskets but all of your baskets are on the same truck, the stock market. What happens when the truck crashes? All of your eggs in all of your baskets are an omelet on the side of the road!
Because gold is not correlated to the market, some of your eggs in some of your baskets are on a different truck.

Three Opinions on Gold Investing

When we look for investing advice, we look to the experts.

Warren Buffett

Warren has given us lots of fun soundbites over the years.

[Tweet text=”I buy expensive suits. They just look cheap on me.”]

This is what he thinks of investing in gold.

“It gets dug out of the ground in Africa or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Buffett believes that gold has no intrinsic value, only the value we bestow upon it, that its value is too highly tied to speculation, and that gold is an inefficient investment as compared to business.

Well, who are we to argue with Warren Buffett? No one but Roy Dalio would like a word.

Ray Dalio

Ray does invest in gold, it’s part of his All Weather Portfolio.

“If you don’t own gold, you know neither history nor economics.”

The history part is the rise of populism in politics and the ever-increasing wealth gap. Similar things were happening in the early 20th Century.

Dalio believes that gold acts in a similar way to cash and is an important hedge against other parts of an investor’s portfolio and that having 5-10% (but no more) of your portfolio, in gold solves the “egg/truck” problem.

Central Banks

Central Banks are rather close-lipped so we can’t look to their words but we can look at their actions. All over the world, Central Banks are “de-dollarizing” their reserves. The U.S. dollar has been the reserve currency for decades and that’s no longer true.

Banks are not buying dollars, they’re buying gold. Lots of it. Last year, Central Banks bought more bullion last year than any time since 1971 when the U.S. ended the gold standard.

Buying gold

Governments across the globe added 651.5 tons of gold to their coffers in 2018, a whopping 74% increase from the prior year. As of February 2019, the U.S. Federal Reserve has approximately 8.77% of its foreign exchange reserves in gold.

Should You Invest in Gold?

There are bad reasons to invest in gold and good reasons to invest in gold.

Reasons Not to Invest in Gold

Some people invest in gold because they think their domestic currency will become worthless. If that happens, gold will still hold value and they can use it to buy water and canned goods. But if all of your spending is domestic, worthless currency won’t matter.

Now, if you’re traveling or plan to live abroad or own a business that transacts outside of your country, it matters. But short of that, investing in gold because you fear your money becoming worthless is nonsensical.

If you want competitive returns (you do!) gold is a bad investment. For the past 42 years, 1975-2017, the average yearly return for gold was 4.8% versus 8.8% for the stock market. Not impressed by those numbers? Ok, try these. Gold gained 720% over the last 42 years while the market gained an astounding 3,428%. Boom! Gold always lags the market.

Reasons Why and How to Invest in Gold

Gold can be a good hedge against a market-based portfolio and solve your “egg/truck” problem.

You can buy gold through a brokerage account like Robinhood or Fidelity, the ticker symbol is GLD. You can also buy shares in a gold ETF. These funds are managed by gold experts. These are 5 recommended gold ETFs.

We did a follow up to the Golden Butterfly episode during a 5 Questions episode and Andrew explained how he built his Golden Butterfly portfolio (gold included) using M1 Finance. M1 Finance is a tool that allows you to automate the proportions you want in your portfolio and they handle the rebalancing for you.

You can dollar cost average your contribution each month, and M1 Finance will rebalance for you by buying more of what you’re out of balance in to bring your total portfolio back into balance. And it’s free to use!

All that Glitters is Gold

Well, we haven’t talked about gold very often in the seven years LMM has been around but we’ve made up for it! Just in the last few months, gold has featured prominently in three episodes, this one included.

And it’s a pretty interesting topic. Like many people, I thought to invest in gold was only something preppers and conspiracy theorists did. So what say all of you? Are you on Team Buffett or Team Dalio when it comes to investing in gold?

Show Notes

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