Why not gold (or Bitcoin)?
Photo by André Fran?ois McKenzie on Unsplash

Why not gold (or Bitcoin)?

Many investors seem to be succumbing to the siren call of gold at the moment. The price of the barbarous relic has jumped over 10% since the beginning of the British ‘summer’. Escalating trade tensions and the fact that ever larger chunks of the government bond market have been sliding into offering negative inflation adjusted returns are among the factors playing a role. This week we explore why the safety apparently on offer with gold may be illusory.

Why the reputation?

Gold’s admirers, and there are many, cite its thousands of years of practice as a store of value. Its more or less fixed supply puts it in a similar camp to bitcoin in some respects – those suspicious of new-fangled monetary experiments such as Quantitative Easing see it as an attractive piece of investment armour. In the same vein, many long for a return of the time when economies, or specifically the value of their currencies, were tethered to this fixed supply of gold. These same disciples tend to see the final shift away from the Gold Standard in the early 1970s as the source of most of our economic ills since, as if there were none before.

The other point to mention about gold, and this can apply more widely, is that if enough investors believe gold to be a safe haven then it may well act as one. As Warren Buffet suggested when asked to comment on gold’s popularity – “the rising price on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As ‘bandwagon’ investors join any party, they create their own truth – for a while”. The same has only recently been true of crypto currencies.

Why do we disagree?

Tethering one’s growing economy to gold, Bitcoin or indeed any other asset where the supply is fixed would inevitably lead to chronic deflation, since a finite supply of bitcoin or gold would be perpetually chasing after an increasing amount of goods. Falling prices may not sound like the end of the world, but the reality is worth avoiding. 

For investors, one of the more important points to focus on is the difficulty in ascertaining an appropriate value to pay for a quantity of gold. For most financial assets, we are aided in this quest by dividends, coupons or other forms of cash flow. These rewards from ownership give us a shot at establishing whether something is expensive or not. For gold, and indeed Bitcoin, that fair value is nebulous – a simple function of what other investors are willing to pay at any one time.

One area where there has been a sporadically meaningful relationship is between gold and inflation adjusted bond yields (Figure 1). The intuition here is that the relative attraction of gold declines as the real yield available on other, more plausible, safe havens rises and vice versa. Why would you buy gold, which throws off no cash flows or coupons, when you can lend the US government money with a yield above inflation so to speak. This relationship has waxed and waned over time, but it is interesting that the recent surge in the popularity of gold and Bitcoin has occurred under the umbrella of plunging real yields around the world.

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Perhaps the most important point for investors looking for shelter from the various storms is that gold has been an inconsistent ally in tougher market backdrops (Figure 2). If it is a safe haven you are looking for, then short maturity US bonds are likely a truer friend. Certainly in nominal terms, they have a much less patchy track record amidst equity market pullbacks (Figure 3).

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Investment conclusion

Gold does have some diversifying appeal, as does bitcoin as it goes. However, for both of these ‘assets’ it is their volatility and their unpredictability that should rule out a dominant role in portfolios (Figure 4). The backdrop, particularly the low to negative real interest rates around the world, is perhaps conducive for both at the moment, however this is not a backdrop that we currently expect to remain in place. In the absence of a recession, we think real bond yields have the potential to move materially higher, which may make life difficult for these coupon less, momentum assets. Until then, we should expect more investors to be sucked into their orbit. There is nothing like rising prices for rising prices, but without fundamental support this is a bandwagon we will likely continue to be wary of.

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On gold and Bitcoin, "....the supply is fixed [and] would inevitably lead to chronic deflation, since a finite supply of bitcoin or gold would be perpetually chasing after an increasing amount of goods.".? ?While Bitcoin has a fixed supply, the units are divisible like no other asset class before it.? A piece of gold could be divided into units only to the point where each piece consists of a spec of dust; there is a physical limitation.? Bitcoin, however, is many more times divisible than gold which makes deflationary fears based on limited supply questionable.

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ángel V.

Chile Minerals & NCRE Sources

5 年

For both of these ‘assets’ it is their volatility and their unpredictability that should rule out a dominant role in portfolios. this is a bandwagon we will likely continue to be wary of. I would recommend investing in raw materials for the electromobility and storage of NCRE

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