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Why Doesn't Gold Get The Respect It Deserves?

Trey Reik, Senior Portfolio Manager 

A longstanding curiosity in the investment business has been the disinterest in precious metals among institutional investors. Whether from the handful of consultants now leading the institutional space, or directly from the stewards of our nation’s pension, endowment, and family-office wealth, skepticism over gold’s portfolio relevance remains fairly pervasive. Because investment professionals are generally well informed, competing in an industry in which performance is king, one would assume any asset class deserving of rightful consideration would enjoy a fair hearing.

In this report, we present a collection of empirical evidence we view as compelling support of gold’s productive role as a portfolio-diversifying asset.

Gold Has Generated Consistently Positive Returns in This Millennium

Eight years of zero interest rate policy (ZIRP) have compressed returns across a wide spectrum of institutional investment regimens. Especially in the pension and endowment world, few portfolios are achieving chartered rates of return. In this environment, we find it puzzling that institutional investors still choose to ignore gold’s market-leading returns. As shown in Figure 1, gold has generated positive annual returns in 14 of the past 17 years. What is even more impressive is gold’s performance compared to the S&P 500 Index, the benchmark for broad U.S. equity performance. Gold’s compound annual growth rate (CAGR) for the 16.75 years (2001 to September 30, 2017) stands at 9.68 percent versus 6.01 percent for the S&P 500 Index (dividends reinvested). Indeed, it is fair to say that since the turn of the millennium, any long-term allocation to gold would have improved total returns for the vast majority of pension and endowment portfolios.

What is it about gold’s performance that is so difficult to embrace?

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009
Gold $USD (%) 2.46 24.78 19.37 5.54 17.92 23.16 30.98 5.78 24.37
SP 500 Index (%) -11.92 -22.10 28.66 10.88 4.91 15.78 5.57 -37.00 26.45
Year 2010 2011 2012 2013 2014 2015 2016 9-30-17 CAGR
Gold $USD (%) 29.52 10.06 7.14 -28.04 -1.72 -10.42 856 11.10 9.68
S&P 500 Index (%) 1506 2.11 15.99 32.37 13.68 1.37 11.95 14.24 6.01

Source: Bloomberg; S&P 500 Index returns reflect reinvested dividends.

Figure 1 (click to enlarge): Annual Returns of Gold Versus S&P 500 Index Since 2001 (2001 to September 30, 2017)

To us, the most interesting aspect of gold’s dogged performance since the beginning of 2001 has been the wide variety of financial, monetary and asset-market conditions that have prevailed during the various years in which gold has advanced. Along the way, every popular variable to which some portion of consensus attributes strong gold correlation has oscillated repeatedly, yet gold has advanced in the overwhelming majority of these years.

Gold Has Provided Strong Protection of Real Purchasing Power

Now that the S&P 500 Index has almost quadrupled from its March 6, 2009 low (666.79), few plan sponsors would equate gold’s potential portfolio “alpha” with that available among U.S. equities. However, as shown in Figure 2, the S&P 500, measured in gold terms, remains 64 percent lower today than at its 2000 peak!During the past two corrections in the S&P 500, during which the index declined 50.50 percent (2000-2002) and 57.7 percent (2007-2009), gold provided unrivaled protection of real purchasing power. We are aware of no reasoning to suggest gold’s portfolio-protection benefits will prove any less potent during the next correction in U.S. equities. In fact, the slopes of the lines in Figure 2 suggest gold’s portfolio-insurance value has rarely been more compelling.

fig2.jpg

Source: MacroMavens

Figure 2: S&P 500 Index Performance Since 1981 (Nominal and Deflated by Gold Price)

Gold Has a Proven Track Record as a Safe-Haven Asset

In documenting an objective record of gold’s portfolio utility, one logically begins with gold’s traditional profile as a safe-haven asset. It goes without saying that gold’s safe-haven reputation accrues from bullion’s established history of relative outperformance during periods of financial stress. As shown in Figure 3, gold has done a masterful job of insulating portfolio capital from sharp declines in U.S. equities during the past three decades of financial crises.

 fig3.gif

Source: World Gold Council

Figure 3: Percentage Changes for S&P 500 Index and Spot Gold (lhs) Versus Absolute Change in VIX Index Level

Gold Has Low Correlation to Traditional Asset Classes

As the investment advisory business has become more scientific, amid increasingly frequent financial shocks, the holy grail of portfolio allocation has become the overarching search for non-correlating assets. Methodologies for identifying and measuring non-correlating assets are in no short supply. However, a routine calculation employed by contemporary risk managers is stress testing portfolio components under simulated conditions of both positive and negative economic trends. As shown in Figure 4,gold’s correlation to traditional asset classes remains uniquely low during periods of both economic expansion and contraction. In other words, gold’s portfolio-diversification benefits are not solely dependent on bad news.

fig4.gif

Source: World Gold Council

Figure 4: Correlation of Spot Gold to Traditional Financial Assets During U.S. Economic Expansions & Contractions (1987-Present)

Institutional focus on non-correlating assets has directed trillions of dollars of investment capital towards hedge funds and specialized investment partnerships in disciplines such as real estate, private equity and venture capital. A more recent trend, however, has been mounting investor backlash against elevated fees charged by alternative managers in the context of mediocre investment returns (not to mention onerous liquidity and lockup provisions). In short, a marquee consideration for today’s pension and endowment stewards has become whether the added fees of alternative investments are truly worth it.

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MARKET SUMMARY

INDICES

Name Last Change
DOW 23358.20 0.43%
S&P 500 2578.85 0.26%
NASDAQ 6782.79 0.15%
TSX 15998.57 0.40%
TSX-V 799.35 0.00%

Resource Commodities

Name Last Change
Gold 1292.66 0.12%
Silver 17.21 0.58%
Copper 3.06 0.62%
Platinum 952.00 1.56%
Oil 56.55 2.49%
Natural Gas 3.10 1.42%
Uranium 24.25 N/A
Zinc 1.45 0.00%

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