Gold is a perfect hedge right now. So far in 2016, stock, bond and commodity markets have collapsed while gold has gone up nearly 4 percent, making it a great insurance policy. At least for a while.
Gold has a lot of things going for it. Governments can’t print more of it, so its value can’t be eroded by inflation or bad monetary policy. It’s a hard asset, so if the world goes mad, it would be a lot more useful to have than paper money. Also, using or transferring gold doesn’t involve leaving a trail for nosy government bureaucrats to follow.
Over the long term, however, gold is a terrible investment. Aside from a good run between 2000 and 2011 when the price of gold moved up 550 percent, other asset classes and markets have done a lot better, as shown below.
The longer the time frame, the worse gold has performed compared with stocks. Over the past 20 to 30 years, gold has outperformed only Japan’s stock market, one of the world’s worst-performing. Gold even underperformed the global bond market for much of the past 30 years. And, owning gold over the past five years would have lost you 25 percent – a worse performance than many other markets.
The fact that gold does not pay dividends also hurts its returns over the long term. Instead of getting paid to own it, like a dividend-paying stock, you have to pay to own gold, for the cost of storage or a good safe.
But, there is more to gold than performance. As we’ve seen in recent weeks, gold is one of the best hedges available when markets go down. That’s partly because the price of gold has nothing to do with what is happening in most stock markets.
When two assets move in opposite directions, they are negatively correlated. When two assets have a correlation that’s close to zero – for example, gold and the Nikkei have a correlation of just -0.02 – it means they move randomly relative to each other. When markets are falling, you want to own an asset that moves in a way that has no relationship with markets, or goes the opposite way.
If you own gold to get rich, you will be disappointed. But if you want it as insurance against the unknown, and against falling markets, it would be difficult to find a better policy than gold.