3rd in Series of Alternatives Investments

TruePoint Capital

Continuing with our discussion on alternative investments, our discussion this week centers on precious metals; in particular, the mother of all precious metals – gold.

If I had to put precious metals into one of the categories listed below, I would say it fit most neatly in the speculation category.

  • Speculation.
  • Growth.
  • Income.
  • Balance.

Some may argue it should fit in the growth category but for the reasons explained below, it’s not a growth asset.

Let’s evaluate precious metals according to the following criteria:

  • Non-Correlation to Broader Markets.
  • Lack of Volatility.
  • Cash Flow.
  • Appreciation.
  • Above-Market Risk-Adjusted Returns.
  • Security (i.e., backed by hard asset).

Non-Correlation to Broader Markets
Precious metals such as gold typically go in the opposite direction as the stock market so, in terms of correlation, most people don’t consider gold to be correlated to the broader market.

This likely has to do with people flocking to gold when they get jittery about the stock market. But that observation has gone out the door this year in the weird world of the COVID-19 pandemic.

In prior economic crises, gold tends to rise as the stock market falters. The Great Recession was the last great example. Gold shot to record highs as the stock market tanked, then as the stock market recovered, gold bottomed out to a record low.

This year has been different.

Even as the stock market has rebounded and achieved record highs so has the price of gold. This wasn’t supposed to happen. Maybe it has to do with the stock market being overpriced. With high unemployment and shrinking GDP, the stock market shouldn’t be at record highs. It’s clear a large number of investors still don’t trust the stock market and have flocked to gold.

Is gold truly non-correlated to the stock market?

Based on this year’s numbers, maybe not as both the stock market and the gold market are both headed towards correction territory.

Lack of Volatility
Precious metals act very much like stocks in many ways with both classes prone to extreme volatility. Just like most stocks, investing in gold and other precious metals is purely speculative.

Making money from gold is based solely on timing – buying low and selling high. The price of gold rises and falls with investor sentiment just like stocks. The argument could even be made that gold is even more volatile than stocks. Just look to the last recession for proof.

After hitting previous highs during the Great Recession and the European sovereign debt crisis, the price of gold dropped like a ton of bricks.

After hitting a low of $800 an ounce in early 2009, the price of gold climbed to above $1,900 in the fall of 2011 only to plummet 40% by the middle of 2013. Back in 2009 when gold hit the then historical high, gold bugs were predicting the price of gold to climb to $2,300. 2013 proved them very wrong.

Cash Flow
Gold just sits there. It doesn’t collect rents, pay interest, or do anything else to put cash in an investor’s pocket. So to answer the question of if precious metals cash flow, the answer is no.

Assets that appreciate have intrinsic value – value separate from increasing prices due to inflation. Assets like agriculture, energy, real estate, and productive businesses have value separate from the price people are willing to pay for them.

That’s because they produce goods or services that consumers want. That’s intrinsic value. Precious metals have no intrinsic value and therefore do not reliably appreciate over time other than from inflationary or speculative forces.

Above-Market Risk Adjusted Returns
In the last 30 years, gold and silver growth has lagged the S&P 500 by a large margin often with the same or more volatility.

Holding physical gold is good in terms of security since you have a tangible asset you could always sell in a bind. However, if you invest in precious metals indirectly through a private or public fund, your investment most likely will not be secured by physical gold.

When it comes to non-correlation to Wall Street the jury is out on gold as this year has gone completely against the grain with gold prices moving in lockstep with the stock market – with both recently hitting record highs.

In terms of volatility and risk-adjusted returns, precious metals are just as volatile as stocks but offer weaker returns.

Physical gold and silver offer a form of security, but when it comes to cash flow and appreciation, precious metals can offer neither of these benefits.

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