Why Gold Is Not The Best Hedge Against Risk Its Supporters Think It Is

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There is a school of thought (?) that is really obsessed with gold. There are two aspects to this obsession: one, that it’s infallible as a hedge against risk. So it should be included in any portfolio with investments in other assets. And two, that the monetary system should go back to the gold standard.

Cullen Roche has a convincing reply for the first aspect: gold is a hindrance as a hedging instrument. The other aspect – that we would gain stability returning to the gold standard -, is an illusion due to the fact that these individuals prefer to drive looking through the rear mirror.

Gold has been stable for a century, but in the last 50 years it has appreciated a lot, seeing a lot of volatility. So it has depreciated a lot.

 

Such a volatile asset is not, in principle, very advisable for protecting a portfolio. It’s been shown that if you introduce a percentage of gold in a portfolio with 50% in Treasury bonds and 50% in equities, it cuts its average value and doesn’t make it more stable. Furthermore, gold represents just 0.58% of the aggregrate total of global assets. So that means putting gold into a portfolio would add very little or, in any event, would be negative because of the volatility in its price.

During the crisis, the principal asset which worked as a safe haven was Treasury bonds, which is logical taking into account that they have been the main big liability used to create money: demand for these assets has pushed the value up so much that they ended up providing below zero returns.

Finally,  if you own a portfolio of assets, the first thing to ask yourself is whether it’s better to invest in a raw material as a hedge instrument, or in the company which uses it to manufacture a product which gives it added value. Is it better to hedge your risk buying oil, or the shares in a company which uses oil to produce petrol? Gold is a raw material and, as such, has a value, but it has a theoretical monetary component which is based on the expectations of the above-mentioned individuals that it will return to the gold standard.

In any event, gold has not shown itself to be a good hedge against inflation, even in the famous case of Zimbabwe. There the companies which continued to obtain real returns despite hyperinflation were the best protection. Hyperinflation and real returns? Well yes, hyperinflation can distort the composition of a product and its distribution, but it doesn’t destroy it.

Gold is a “barbarian relic”, and wanting to re-establish it as a standard of value is as reactionary as wanting to bring back the Inquisition.

About the Author

Miguel Navascués
Miguel Navascués has worked as an economist at the Bank of Spain for 30 years, and focuses on international and monetary economics. He blogs in Spanish at: http://http://www.miguelnavascues.com/