What’s So Great About Gold? - Adviser Investments

What’s So Great About Gold?

August 26, 2020

Episode Description
FEATURING Jeff DeMaso and Josh Jurbala

Even following its surge as one of the highest-flying investments of 2020, the merits of gold remain hotly contested. For every passionate goldbug, there’s someone else dissing it as a fringe fad. But with its recent popularity and sharp rise in price, are you missing out without gold?

Listen to this lively discussion between Director of Research Jeff DeMaso and Quantitative Investments Manager Josh Jurbala as they present the evidence you need to decide if this polarizing investment option is right for you.

In this illuminating conversation, our experts dispense with the hype and deliver everything you need to grasp this often misunderstood investment, including:

  • Why is gold having such a breakout year?
  • What are the arguments for and against investing in gold?
  • What risks may gold present in your portfolio?
  • Is gold really an effective inflation hedge?
  • Are gold ETFs a savvy play?
  • …and much more

Gold has held a long and prominent place in investment history, but the debates about its true worth can create more questions than answers. For a definitive look at the potential benefits and drawbacks for investors, click above to check it out now!

 

Episode Transcript

Jeff DeMaso:
Hello, and welcome to another The Adviser You Can Talk To Podcast. I’m Jeff DeMaso, Director of Research at Adviser Investments. Today I’m joined by my colleague Josh Jurbala, our Quantitative Investments Manager. In English, that means Josh leads our tactical strategies. Josh, welcome to the podcast.

Josh Jurbala:
Hey Jeff. Good to be here. Let’s talk some gold.

Jeff DeMaso:
Yeah, gold indeed. Gold is the third rail of investing. So we’re choosing a meaty topic for your inaugural The Adviser You Can Talk To Podcast.

Jeff DeMaso:
All right. Why is gold so…Why am I calling it the third rail? Why is it so incredibly polarizing? It’s that there’s diehard gold bugs and there’s other people who dismiss gold is a pet rock. Coming down on either side can lead people to just dismiss you offhand, and while we do want to come down and have an opinion on gold, we know that emotion is the enemy of sound judgment.

Jeff DeMaso:
So Josh, I think what we want to do here is let’s try and keep emotion out of the picture as we talk a bit about gold today. We can provide some of the basics on gold, review both the bull and bear cases, dig into what’s happening and then try and sum it all up with our view on gold. But let’s try and provide a bit of level-headed education first. How’s that sound?

Josh Jurbala:
Yeah. Sounds great to me. As you said, I run tactical quantitative strategies and I love to keep emotion out of things, so let’s do it.

Jeff DeMaso:
All right. Perfect. Okay. Let’s maybe start with what is gold and importantly, why is everyone, including the two of us, talking about it today?

Josh Jurbala:
Yeah, sure. So gold is a precious metal. It’s been around for centuries and it’s been used in jewelry and technology, as a currency and store of value in coins and gold bars. It’s also traded as a commodity and it’s invested in as a diversifying asset for investors to hedge against global risks and possible inflation. So as to why we’re talking about it, the short answer is that gold is up over 30% this year and investors see those big returns and they want to know if they should buy in.

Jeff DeMaso:
Yeah, I can see why 30% might get some headlines. We’ll dig into it in detail, but maybe just give me the quick and dirty answer of why is gold up 30% this year?

Josh Jurbala:
Yeah, sure. So we’ll get into this, but gold is up because the narrative behind it’s hitting on all cylinders this year, which is driving investors to buy gold in droves. That narrative’s based on three themes. The first is safety, and investors are just looking for safe havens or assets to protect their portfolio from global risks.

Josh Jurbala:
The second theme is opportunity cost. That’s because typical safe havens like US treasuries are yielding so little these days, investors don’t want to just hold bonds or cash.

Josh Jurbala:
That third theme is inflation. Investors view gold as an inflation hedge and store value. They see unprecedented monetary stimulus from central banks and they just anticipate inflation increasing. So they think gold is a hedge against that.

Jeff DeMaso:
All right, let me pull that value idea, storing-value idea. More fundamentally, ignoring what’s going on today maybe, what makes gold valuable or unique?

Josh Jurbala:
Yeah. Gold is very unique because it plays a dual role as a commodity and a currency. As a commodity, it gets value from its use as a raw material to meet fundamental needs, like jewelry making or to make small parts and technology. Then that other use is a currency, where gold is a medium of exchange and it’s viewed as a possible safe haven and store value. So that currency store of value theme is why most investors are interested in gold, and that’s why we’ll focus mostly on that theme today.

Jeff DeMaso:
Okay. So gold historically has been a currency and it’s got some uses as a commodity. That seems simple, I guess. But why is it so difficult and polarizing? Why is it hard to allocate to?

Josh Jurbala:
Yeah. I think the first reason you went over in the introduction. It’s a polarizing subject, so it’s hard to get unbiased information on gold. People are either staunchly gold bugs or staunchly gold bears. It’s hard to get a moderate take on it.

Josh Jurbala:
Then the other difficulty with gold is just its complexity. There are so many drivers affecting the price of gold, and sometimes those drivers conflict with each other. For instance, I mentioned that inflation’s a tailwind for gold or a positive driver for gold price, while economic growth can lead to inflation. If the economy improves, that offsets the need for safe havens in the first place.

Josh Jurbala:
So just that complexity, those conflicted drivers and the fact that gold is just a global asset and trades in a lot of different currencies. It just makes it hard to wrap your head around sometimes. I think that’s why we wanted to talk about it because it’s not the slam dunk investment people are saying that it is these days.

Jeff DeMaso:
Yeah. That’s an interesting point that those narratives sometimes can conflict almost, as you point out with inflation there.

Jeff DeMaso:
Okay. We’ve both mentioned gold bugs and gold bears. Let’s take them in turn. Maybe talk to me about what is that bull or gold bug in the parlance case for gold. What’s the argument for buying gold?

Josh Jurbala:
Yeah. The gold bug case leans heavily on that store value, inflation hedge argument. That’s based on two characteristics, scarcity and security. Gold is relatively scarce across the globe. The World Gold Council estimates that nearly 200,000 tons of above-ground gold exist in the world, and two thirds of that has been mined since 1950. Just to get a sense of how much that is, it sounds like a lot, 200,000 tons, but all gold ever mined would fit on a football field piled less than ten feet high. So just think about that, all gold in the world on just one football field, less than ten feet high. When it’s mined each year, that adds less than the thickness of a coat of paint to that total. So just that scarcity, yeah, it’s crazy.

Josh Jurbala:
So just that scarcity is why gold is seen as a store of value, because in a world where people are, the way people say that central banks are printing money to help us through this global recession, people are looking for those scarce physical assets, and that leads me to the security point.

Josh Jurbala:
Gold’s practically indestructible, and most of that mined gold’s still here today in the form of jewelry, gold coins and gold bars. So that supply is largely static. Just the such the fact that it’s a global asset which central banks use in their reserves just makes it a very secure asset to hold.

Jeff DeMaso:
Okay. I get that. I can see some of the appeal there of “we’re not creating a ton more gold.” It’s a finite amount. It’s hard to get. But once you do, it’s not going anywhere. Certainly feels different than the printing of central banks, if you will, or the changing decimal places on a computer screen.

Jeff DeMaso:
All right. What’s the other side? What’s the bear case? Why wouldn’t I invest in gold?

Josh Jurbala:
Yeah. The gold bear case pretty much rests on the fact that it’s not a cash-generating asset. Warren Buffett’s a notable gold bear. He sees gold, he thinks it has no inherent value and it just has a lack of usefulness.

Josh Jurbala:
Jason Zweig, he actually calls gold a pet rock. It just sits there, he thinks. That’s the primary argument, it’s not a cash-generating asset and it’s not like equity which have earnings and dividends or a fixed income asset, which has a yield and repays principle at the end. It’s not real estate, which is a physical asset but could provide rent income. So it’s just not a productive asset in a bear’s view.

Josh Jurbala:
Then just in terms of it not being a safe haven, it’s volatile. It’s been through some very large drawdowns, even in the late ‘70, early ‘80s when there was hyperinflation, which was an ideal time to invest in gold. There were still drawdowns of over ten percent, equity-like draw downs. It was tough to hold through those times.

Josh Jurbala:
In 2008 gold fell, along with the market for a while there, even though eventually it did help buffer through the recession. It’s not always the buffer it’s made out to be. Even recently we saw in March gold fell over ten percent within eight days. During the worst of March, we saw people selling all assets for cash. So it wasn’t the safe haven people rely on in that time.

Jeff DeMaso:
Yeah. I’m going to toss one more stat on top of that. It’s one of my favorite stats about gold. It’s actually over the past 40 years, so just since the end of the ‘70s, which admittedly was an incredible run for gold in the ‘70s. But over the past 40 years, nonetheless, gold has actually underperformed money market funds and it’s to your point done so with massive amounts of volatility.

Josh Jurbala:
That’s a good point, good point. That goes against the whole store value argument. It can lose value over long periods and it can underperform. There’s probably better alternatives over a long period of under performance like that

Jeff DeMaso:
Let’s get into specifics. We’ve talked a bit about gold having good runs, gold being volatile and having some big draw downs. So Josh, what drives the price of gold and what’s driving it today?

Josh Jurbala:
Well like any traded commodity, supply and demand affect gold prices. Supply, as I mentioned, doesn’t really fluctuate too much even though the pandemic did slow mining this year. That hasn’t had a major effect on price.

Josh Jurbala:
Then demand has actually fallen, overall demand has actually fallen year over year. Consumer demand for physical gold fell, especially in India and China. Typically, that’s over 80 percent of total demand for gold in the world, just for jewelry, gold bars and coins, a global recession and a loss of income among much of the populations in these developing countries.

Josh Jurbala:
Then higher gold prices in the first place. Gold was already pretty high in historical terms. That just makes it less affordable for other populations. So overall consumer demand was down.

Jeff DeMaso:
Okay. So, if demand is down and … Now if I remember back to my economics courses, rising demand leads to rising prices. Falling demanda suggest that gold prices should be going down, but they’ve gone up this year. What’s going on?

Josh Jurbala:
Yeah. Good question. That’s where you get into the ETFs. Investment demand is driving flows into ETFs, which is really driving the surge in gold price. That just shows even though ETFs are less of a percentage of typical demand, price can be driven solely by a narrative and flows into ETFs. Those flows are based on what I’ve talked about in terms of there’s a low opportunity cost because interest rates are so low. Gold usually goes up when interest rates are low, and even provided a negative real return. So sitting in cash is just not worth it and people are looking for return elsewhere. That speaks to the whole TINA theme, which we’ve talked about in other podcasts and other communication, that “There Is No Alternative” theme that drives people from bonds into other assets, sometimes riskier assets like stocks.

Josh Jurbala:
But then again, there’s still that safe haven that people want. So they look at gold because they’re afraid of financial market risk just brought on by the pandemic, geopolitical concerns, the upcoming election, and then add onto that all those other factors in terms of inflation.

Josh Jurbala:
I think the final factor that’s driving gold price up is just technicals. As a tactical manager, I look at technicals a lot. We base our strategies on price momentum, and this is when I would use one more acronym, FOMO, that “Fear Of Missing Out.” People see something going up and they want to buy more of it and crowds rush to buy that trade. So everyone’s rushing to gold. All this together just creates an investment theme that drives flows into ETFs and drives up the price of gold further.

Jeff DeMaso:
Yeah. The FOMO theme, one thing that Dan and I have talked about in past podcasts. But let’s keep talking ETFs because they clearly are the marginal dollar in gold it seems really dictating price whether people are buying or selling ETFs and ETFs have made it easier to buy gold. But what’s the difference just between a gold ETF and physical gold, and are there any other ways that we should consider investing in gold?

Josh Jurbala:
Yeah. So there’s an important distinction to be made between gold ETFs and physical gold. Gold ETFs provide the exposure to the price of gold, but you don’t actually hold the physical bars yourself. ETFs are accessible and liquid, so they’re sufficient to gain exposure to the price of gold. But it’s just important to note that they’re not as safe and secure as physical bars. So if you’re looking for that security that is one of those themes behind investing in gold, just know that with ETFs, there’s some risk still there.

Josh Jurbala:
Then the other way to get gold would be physical gold in terms of actually trying to purchase those bars. You could obviously purchase jewelry if you want, but some people, I’ve seen commercials all over the TV recently, which just shows the hype over it recently. You could see coins and gold bars being advertised for safety. So that’s another way you could hold them.

Josh Jurbala:
But the thing is, is to realize that you’re always going to have some counterparty risk, which is just the fact that you rely on a bank to hold all this for you in a vault. There are fees associated with that. There are contracts to sign. Just understand that if you’re afraid of the financial system collapsing, that doomsday scenario, which we don’t see. We’re optimists. We trust the financial system. But if that’s your reason for buying gold, just understand that there’s still risk involved.

Jeff DeMaso:
Yeah. I agree completely Josh, particularly on the gold ETFs. As you said, easy for trading and particularly useful for tactical strategy. But if you think you’re owning a gold ETF because you might need to get your hands on that gold and spend it, well in that scenario, most of the gold bars are held over in London. It’s going to be pretty difficult to expect there to be a system in place to get it to you when you’re going to need to spend it in that doomsday scenario.

Josh Jurbala:
Yeah. Actually, that’s what happened in March. The doomsday scenario seemed to happen in the worst of March. All travel was shut down because of the pandemic, and there was even an issue with people trading gold and the fact that they didn’t know if they were going to be able to get it delivered. So yeah, to your point, you’re still relying on the global financial system and other counterparties to actually store and deliver your gold.

Jeff DeMaso:
All right, and there’s one more way to buy gold. Actually, there were some headlines around this with Warren Buffett and Berkshire Hathaway. The headlines were a bit lazy saying Warren Buffet buys gold, when in actuality was probably one of his lieutenants and they were buying a gold miner. So give me a little bit on gold miner. How’s that different from buying a gold ETF or the gold bar or coin?

Josh Jurbala:
Yeah. So this is one way to get exposure to gold. You are investing in an actual company, so I do like that aspect of it. But understand miners are still very risky. So gain, to the point of security and safety, if you’re looking for that, you wouldn’t find it invested in a gold miner. They’re very reliant on the actual price of gold. The cost of mining, of actually mining gold, can be pretty high. So just be very wary. This is not going to be a cash position. This is going to be a high-risk equity position in your portfolio.

Jeff DeMaso:
All right, great. So Warren Buffet’s got some capacity to take risk. He can handle drawdowns pretty well.

Josh Jurbala:
Exactly. Yup.

Jeff DeMaso:
Great. All right, Josh. I think we’ve covered a ton of ground. We’ve walked a long way on the yellow brick road here. I think we need to try and sum up here, come down, where do we stand on gold? What’s our advice when it comes to investing in gold?

Josh Jurbala:
So our advice is first just understand why you’re buying. Are you buying because you want that store of value or inflation hedge and ask yourself, what is the chance of really having inflation or significant inflation in coming years? We’ve had QE, we had QE after 2008, and this was part of the reason gold ran up in 2011. People were nervous of inflation. It never materialized.

Josh Jurbala:
Then to that point that I mentioned earlier about the conflicted themes, if economic growth causes inflation, then why would you want to sit in a safe haven at that time? Why not just own equity? So I think that’s one takeaway, is why not just own equities if you’re worried of inflation.

Josh Jurbala:
If you’re buying it against a depreciating dollar to hedge against the depreciating dollar, in my view and I think the firm’s view, the fears of the U.S. dollar being replaced as the world’s reserve currency have just been greatly exaggerated I think. U.S. dollar is still seen as a global safe haven. There’s always going to be people rushing to buy cash during the worst of times. So we don’t see gold being that buffer in your portfolio that you can rely on. So just in terms of a depreciating dollar against other currencies, you could own international and emerging markets just to benefit from that weakening dollar.

Jeff DeMaso:
I agree Josh. Those are some important questions to ask if you are considering buying gold, and within your answers you mentioned that there’s some other assets like equities that might be able to benefit from some of the things that could help gold increase in price. So at the end of the day, how do we at Adviser Investments think about gold as an investment and using it?

Josh Jurbala:
We use gold as a tactical tool not a strategic investment, which just means we use it in our tactical, quantitatively-managed portfolios. So we view it as a risky option within those portfolios, not necessarily a cash buffer, a cash-like buffer. That just means that we’re able to get defensive and sell gold hopefully towards the top or a peak like right now. That’s the way we look at it.

Josh Jurbala:
We just don’t think that FOMO, investing at the peak price like it is now is a good long-term investment strategy. But it does help create momentum which can benefit a tactical portfolio.

Jeff DeMaso:
No, I think you’re spot on with that tactical, not strategic. Although you’re the quantitative manager here, I’m going to toss out one more stat to close up on here.

Jeff DeMaso:
Focusing on the idea of holding gold strategically may not be the best way to really grow your wealth over time. So the Vanguard 500 Index Fund was launched in 1976. So if we compare a $10,000 investment made in Vanguard 500 Index to a $10,000 investment made in gold in 1976, we see a pretty big difference. That $10,000 in gold is worth $175,000 today. That sounds good, but your $10,000 investment in 500 Index is now worth around a million dollars.

Jeff DeMaso:
So again, I think it comes back to are you a strategic investor looking to grow your portfolio over time? Are you looking more tactically to try and take advantage of some price momentum or as a bit of a diversifier in your portfolio?

Josh Jurbala:
Yeah, that’s a great point.

Jeff DeMaso:
Thank you, Josh, for joining me on this walk by the third rail of investing in gold. It’s got a long and prominent place in our history and it’s going to continue to. But again, at the end of the day if we’re thinking about wealth creation, it’s done by investing in stocks of companies that are growing their earnings and making our lives better day in, day out.

Josh Jurbala:
Yeah. Thanks for having me Jeff. This has been great.

Jeff DeMaso:
All right. This has been Jeff DeMaso and Josh Jurbala from Adviser Investments, thanking you for listening to The Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe and review our show. You can check us out at adviserinvestments.com/podcasts. Your feedback really is always welcome. If you have any questions or topics that you’d like us to explore, please email at info@adviserinvestments.com.

Jeff DeMaso:
As always, I’d like to thank Kailey Steele and Ashlyn Melvin, our editors for making this podcast a reality. And thank you for listening, and stay safe.

Podcast released on August 26, 2020. This podcast is for informational purposes only. It is not intended as financial, legal, tax or insurance advice even though these topics may be discussed. Information and events addressed in this podcast, as well as the job titles, job functions and employment of the podcast’s participants with respect to Adviser Investments, LLC may have changed since this podcast was released. For more information on each individual featured in this podcast, see the Our People section of our website.

The Adviser You Can Talk To Podcast is a trademark of Adviser Investments, LLC.

© 2020 Adviser Investments, LLC. All Rights Reserved.

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There are so many drivers affecting the price of gold, and sometimes those drivers conflict with each other…It’s not the slam-dunk investment people are saying it is these days.


Josh Jurbala

Quantitative Investments Manager

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