The Strategic Role of Gold in Investment Portfolios

Unlock the secrets of gold as an investment with Steve Davenport and Clem Miller, as we venture beyond common misconceptions to reveal gold’s appropriate role.  From the possibility of gold being the ultimate protector of wealth during severe economic or geopolitical upheaval, to historical instances where governments have stepped in and seized private  gold holdings, we cover it all. Our conversation navigates the performance of gold versus stocks in various inflation scenarios, and we probe the motivations behind central banks and individual investors in buying and holding gold. 

This episode offers guidance incorporating this precious metal into your portfolio. We delve into the appeal of gold in nations such as India and China and dissect the advantages and potential pitfalls of gold ETFs. With a sharp focus on the strategic inclusion of gold in your asset allocation, we consider just how much gold you might want to hold in your portfolio. Join us, and let’s together  navigate the golden path between myth and solid investment strategy. 

Straight Talk for All - Nonsense for None


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Transcript

Steve Davenport: 0:26

Welcome everybody to Skeptic's Guide to Investing. I'm Steve Davenport and I'm here with my partner, Clem Miller. In this episode we're going to explore the various perceptions and myth perceptions regarding gold as an investment. We're going to discuss the proper role of gold in your portfolio. Many people use it to hedge against geopolitical risk or high inflation. Some people just like the feeling of owning gold. Let's first consider gold's role in hedging against inflation. Clem, can you tell us what hedging is and your view of gold as an inflation hedge?

Clem Miller: 1:03

Sure, Steve, and thanks for this episode today. An effective hedge is one whose returns keep pace with inflation. That is, an effective inflation hedge is one whose returns keep pace with inflation. One thing people don't realize is that stocks are actually a more effective inflation hedge than gold when inflation levels are moderate. So stocks are actually more effective when inflation is moderate. Gold is a more effective hedge than stocks during those relatively infrequent periods when inflation levels are very high. Thus, the percentage of gold you should hold in your portfolio should depend in part on your views regarding the likelihood of very high inflation levels.

Steve Davenport: 1:56

Yeah, it's been doing exceptionally well recently, and I think that gold is telling you one thing with it keep reaching new highs and the market keeps saying we want three rate cuts. So I'm not sure who's right and who's wrong, but there are conflicting signals and I always like those conflicting signals because they highlight the fact that at least other people are thinking of things differently. Some folks fear that the US will suffer from hyperinflation and that the US currency will become worthless. I'm not one of those people, because I look at a lot of other currencies, like Turkey and Venezuela and other places where we've seen what really is happening when a currency and a government go off the rails. Some gold sellers play on these fears. Glenn, do you think the holding of a lot of gold would protect investors against hyperinflation?

Clem Miller: 2:52

So, yeahs, let me just go to your point about hyperinflation in other countries. When you look at countries like, as you mentioned, turkey, and we'll add to that Zimbabwe at one point, or, Nigeria at times, , some of the Latin American countries, you're talking about double digit levels of inflation, sometimes even a triple digit levels of inflation, and I'm sure all of you have gotten, emails or have been on broadcasts or whatnot, where there have been folks who have been really, trying to terrify you about future hyperinflation in the United States and you know are saying, well, gold is the answer to that. Precious metals, gold, gold, gold, buy our gold. There's a lot of fear being installed by these advertisers, but one thing that these advertisers don't tell you, or a lot of people don't tell you, about gold as a protection against hyperinflation, is that it's really actually hyper-dubious.

Clem Miller: 4:11

Rather than to use the term hyper, history tells us that during a hyperinflationary episode, the government would want to reestablish a gold standard, which they can easily do by seizing investors' gold holdings. So this is what Franklin Roosevelt did in the 1930s he expropriated nearly all of the gold held by US citizens, providing only minimal compensation to those from whom he expropriated the gold. He made it illegal to hold gold in all but trivial amounts. Thus, in a hyperinflationary episode, you're much more likely actually to lose your gold holdings than to benefit from their use as an inflation hedge.

Steve Davenport: 5:04

Yeah, I think that. I mean, I've spent a lot of time with a lot of clients because I personally own a private equity gold investment and when I think about gold, I get back to what we were talking about with Kahneman in terms of this economic animal, and I say all of the central governments and treasuries around the world have ownership of gold as part of the backing for their currency.

Steve Davenport: 5:31

They're not formally backed, but the US has its currency backed by 10% gold. China is somewhere around 1%. China wants to be the leader with their currency, the yuan around the world, their currency, the yuan around the world. But if it's backed by 1%, then the US is backed by 10% gold. Is either one really backed? I would argue 10% backing is a floor, but it's a pretty low floor, so I don't see it as a backing.

Steve Davenport: 6:03

But when you look at the last two or three years, a lot of countries the number one buyer of gold has been central banks. So the number two buyer of gold has been ETFs. So individuals have a need for some stability and some countries have a cultural. You know India and its weddings is culturally tied to gold and when their daughters marry they have a dowry that is usually positioned mostly in gold. China doesn't believe its government is going to take care of the yuan. The Chinese retail investor owns a lot of gold. They are always looking for gold. They take every bit of gold that is produced in China and they use it to back the currency. And then individuals are looking for ways to own more gold.

Steve Davenport: 6:59

So when I look at gold, I think of it as a 4,000-year-old asset that we keep saying doesn't have any meaning or space in our lives. But my question is if it doesn't have any meaning, why do all these central bankers go and buy it to back up their currencies? It would seem that these central bankers and economists, they've gone to college. I think they have graduate degrees. I got to assume they're somewhat rational. Graduate degrees, I got to assume they're somewhat rational. But they're the number one buyers of gold. So it's a little hard to me to find if we have people doing things in the marketplace and we just say, oh, it doesn't make sense, but I'll just ignore it. I can't ignore people who are behaving irrationally because if they're going to behave that way forever, I want to get in front of them, right? I want to take advantage of this irrational behavior and try to make some money.

Clem Miller: 7:58

So, Steve, this may be a point where you and I disagree, which is, which is fine, ok, but yes, I know you could be wrong. Okay, but yes, I don't know if you could be wrong, Clem, I'm fully aware of that. So, steve, you're absolutely right that there are some governments that are building up their gold reserves. They're far, far below what's needed to back up their currencies, if indeed they try to move to a gold standard. But you know they are buying gold and they must be buying gold for a reason, and the only reason you can think of is that someday they may try to move towards some kind of gold standard, even if it's a partial gold standard, such as 40% backed or 50% backed.

Clem Miller: 8:49

But the point of their buying gold and maybe moving towards a gold standard actually supports what I'm saying about the risk of private individuals holding gold. Because what could happen if these governments are interested in backing up their currencies in the event of hyperinflation and moving towards a gold standard? They're not going to stop at buying gold at market prices. They're going to try to expropriate gold from individuals such as you and me and pay very low prices when they do expropriate that gold. So I see this as being a risk. This expropriate that gold, so I see this as being uh being a risk. Uh, you know this, uh this expropriation possibility.

Steve Davenport: 9:34

It's happened before and it can happen again. I've heard about government doing that and going off the gold standard and I've read the history. You know the history is informative. The question I have is really about how do we take things like the cultural need for gold in India and look at India's economy growing and say, well, I don't think there should be any demand for gold. Well, I can't say that because there's a need in that culture when you try to use gold as a transmitter.

Steve Davenport: 10:07

And then I look at what happens with China and I say, why is China into Bitcoin? Because they want to take assets easily, transport them. $100 million of gold, that's kind of hard to fit in the suitcase. So you do it with, you know, bitcoins and you take those little Bitcoins on your device and you go out of China and then you convert it to gold which can then be physically moved.

Steve Davenport: 10:32

The physical aspect of gold as a store of value is where I guess I agree it's a component of value, but it isn't a large component. I just think that there's so much irrationality around the subject that I agree that your feelings about expropriation is a good idea, but it's one of many, many ideas. In terms of this, you know, I've had clients who are high technology clients and they want to talk about having a bunker and in the bunker they have foodstays and they have gold and they have you know lead to protect themselves and they have, you know jets available to take them to these bunkers should there be a nuclear event. These are CEOs of very large companies that I think we would all know. Why do they feel this way? Because of the financial markets at times and I know that you'll find this a little bit frightening I'm not sure they're rational about it.

Clem Miller: 12:01

So, Steve, what do you think about ETFs? And then I'll tell you my thoughts about ETFs, gold ETFs.

Steve Davenport: 12:15

GLD is a real asset that you should own. And I look at that and I say, okay, where were these people three years ago smething interest rates were zero? I didn't hear anybody say nobody should own fixed income because with inflation at 3% and the interest rate at zero, I'm paying 1% to a manager to manage my fixed income. Why would I pay somebody a carrying cost for an asset that produces nothing? It only loses purchasing power. I didn't hear those people tell me why we should own fixed income. I heard those people go silent, even though they are the same people who criticize gold as not delivering income. So my comment is gold can be an asset that you hold and, if you want, you can write calls against it, just like you write calls against any equity you own, and those calls will easily generate more than what you get from what you pay for the fee to carry the gold.

Steve Davenport: 13:43

The GLD is one of the most liquid instruments in the world. It's about 44 billion that's billion annual. It's 44 billion in assets managed and it trades very liquid with very little spread and it's backed by physical gold in London. I realize that it is an ETF and I realize that it does have its structural questions about how a government could seize it. But I'm also saying that it will be a little more involved because the assets are actually the most liquid exchange for gold is the London exchange and therefore it's not under the US government.

Steve Davenport: 14:26

So it feels like there's a lot of details here that need to be worked out. But bottom line, gold is an asset that can be easily transported and if you have it it can be helpful. If you don't have it, it's something to consider because you like to be able to say I'm taking this risk of hyperinflation and I'm doing something to mitigate it. You're not doing everything to mitigate it. But again, if the probability of the event is less than 5% or less than 2%, how much can you allocate to probabilities that are so low?

Clem Miller: 15:05

So, Steve, personally I think too many people think that if you just put an ETF wrapper around some kind of investment or alleged investment, that it actually improves things. And I'm, for example, wrapping an ETF structure around Bitcoin. I don't think it improves anything really. So I would say the ETF structure actually makes it easier for governments to seize investors' gold. I mean, you mentioned that gold for the GLD is held in London. Gold for some of the other ETFs is held by custodian banks here in the United States. But the thing to realize about these ETFs is that the investors in these ETFs don't actually own the physical gold. They own shares in a trust that owns the physical gold. So nobody investing in these gold ETFs should be under any illusion that they're actually investing or have an ownership stake in the physical gold. They don't. They have an ownership stake in that trust, and so the government.

Steve Davenport: 16:26

They are transferable into physical. . Know I have a clients that are large holders of gold and we've looked at opening a custodian account here and having the exchange from you. Know you can do just like your question about governments taking over the securities. At first, I'd ask you can't they do that with every equity holding? Can they do that with every mutual fund and ETF that exists for all of the other assets? Like, why are we talking about the government having this power on gold, but we didn't mention it when we talked about the?

Clem Miller: 17:05

S&P. Well, and the reason I'm talking about this, steve, the reason I'm talking about this is because we were talking about one reason for holding gold. It goes back to governments looking at gold as a potential item to back up currencies and there's been a history of governments seizing private gold in order to reestablish gold standards. And if we're concerned about potential, or if an investor is and I know you and I aren't so concerned about hyperinflation in developed countries, but if there are folks, if there are clients out there who are concerned about hyperinflation, they should be concerned about gold potentially being seized in the future to back up future. You know the reestablishment of gold standards and I would say that, as I mentioned, it's relatively easy for an ETF structure to lend itself to having its gold seized. The investors don't actually own the gold, they own the shares and you know, additionally, the gold is physically located in large vaults that are maintained by custodians, so it's really very convenient for a government to seize this gold and move it into government vaults, sure.

Steve Davenport: 18:42

And we can look at you know. I would just say that there is some advantages to the physical gold versus in oil. When you have an ETF in oil, it has futures contracts on the oil, and so the futures contracts have their own characteristics. You obviously can't exchange your oil ETF, uso, for barrels of oil. You can only get futures contracts. That's the exposure. So there are ways for you to exchange the ETF for physical gold and get delivery. Just like ETFs get created, etfs get redeemed, you can redeem your ETF.

Steve Davenport: 19:25

I think it's a minor point. I think that we've covered inflation. Now the thing that I think that I find is very much interesting is this idea of geopolitical risk. How do you think gold holds up as a and just as an aside? I was reading this morning about Taiwan and this typhoon that has hit in Taiwan and potentially, I started thinking about well, we're worried about China invading Taiwan. Thinking about well, we're worried about China invading Taiwan, but a monsoon comes through and wipes out the chip factories and all those people who are betting on Taiwan getting destroyed by China. Now we forget about Mother Nature as the ultimate destroyer of properties, right? How do you think government's involvement with geopolitical risk can make gold a holding that you should consider.

Clem Miller: 20:26

Yeah, it's interesting you should mention Taiwan, because semiconductor plants actually depend a lot on very clean water and that might prove to be a problem during a typhoon. So what investors call safe havens, or at least safer havens, gold is often one of those havens. The gold price tends to be higher temporarily during geopolitical risk events. So, yes, gold is a good hedge during periods of high geopolitical risk and perhaps a reason to hold some gold, some level of gold, in your portfolio.

Steve Davenport: 21:30

Sure, I think that if we're talking about a major war, one of those could close banks or paralyze the system. I often hear about refugees who escaped during World War II with gold, jewelry and stuff around their belts and on their bodies and they didn't have many assets, but they had that gold to help them go to a new country and get reestablished. Many assets, but they had that gold to help them go to a new country and get reestablished. I see why people would want to hold physical gold in some cases, in case things really go. So what do you think about gold and gold jewelry in this case?

Clem Miller: 22:09

Sure, you might want to keep some gold jewelry or gold coins just in case, and if you're like one of these billionaires that you were referring to, steve, you might want to have bars of gold hidden in a cave somewhere. But as far as these gold-linked ETFs are concerned, which really a lot of retail investors and folks we know have some exposure to, as far as those gold-linked ETFs are concerned, you really can't count on them protecting you against a financial disaster. That's because these gold-linked ETFs themselves depend on the global financial system, shut down the financial system, and nobody can sell their shares in these ETFs.

Steve Davenport: 22:58

Correct. I mean, we need markets to be open during a financial disaster, you could have a period of time where markets are not. I understand that shutting down the system affects these ETFs and I'm not saying that you have to have your gold exposure through those ETFs. I think there are gold miners, there are other ways to get exposure to this space and I don't think it's clear there aren't enough financial system collapses for us to really make a full analysis in terms of how many data points we have in the last 10, 15 years to tell us what the reaction and the price reaction will be.

Steve Davenport: 23:39

So, without enough data, I think we're all just kind of you know, given our opinions, and I think that for most people, this is a question about how much and where, and I think that you know we're open to the idea of gold constituting a small part of the investment portfolio. I also remember our chief investment officer, as you probably do, saying that if you're going to hold physical gold, you also need to hold some lead to protect the physical gold from being taken by someone else. So here in the South, there's a feeling that government might come looking for my gold and I'll want to protect myself. So do you think there's, you know, any reason to exclude gold?

Clem Miller: 24:40

to exclude gold. To exclude gold, so no, I can't think of any reason to exclude gold. I think the only question really is I mean the way you phrase that to exclude gold. There's no reason to exclude gold. The question is whether you want to include any or to what extent you want to include any. And I would say that it's in a situation where you have moderate inflation, which we're back down to now, certainly and have moderate geopolitical risk, and one can argue as to whether that we're in that kind of situation or not. I think in those cases it's logical to have no gold, right? I think that you know. I think that it's also logical in the current environment to have a small goal, holding, say, 5%. But some people who think that the world is going to fall apart sometime soon, either in terms of hyperinflation or in terms of geopolitics, are thinking well, maybe I should hold 25%, 50%, 75% in gold, and I totally disagree with that sentiment. I don't think there's that much benefit to be obtained by having that much gold in a portfolio.

Steve Davenport: 26:14

Let's open the mailbag. It looks like there's two questions. The first question is what do you think is the maximum percentage of gold you should hold in your portfolio? Second question is whether you yourself hold any gold.

Steve Davenport: 26:28

So, as for me, this brings up an issue that I think is kind of intrinsic to all people's assets. I would like people to stop thinking about their assets as their investable assets. I think that you need to include your real estate in those assets when you think about your wealth, because real estate is one of those assets that will help you in an inflationary environment, because real estate tends to go up. So when I look at my wealth, I don't look at my wealth of my investments. I look at my wealth of everything, the wealth of my home and the mortgage to net out what is my home equity exposure, and then I look at things like gold and art as other assets that might be considered in your overall wealth, then investment assets and then look at discounting future Social Security and pensions. So I think that's different than what a lot of people would do, but I feel like if I have an annuity that starts when I'm 67 from social security system and I'm 60 now, that annuity lasts, whatever my lifespan is. I can estimate the lifespan. I can estimate the payments. They're adjusted for inflation, so they're better than a pension I have from a bank in Buffalo, so they're better than a pension I have from a bank in Buffalo and it's something there that has some value.

Steve Davenport: 28:06

Therefore, you should think about your overall allocation as all your assets, your pensions and social security, your real estate and then think about percentages. So my question would my answer would be yes, I own gold. I have an investment in private equity that has a value somewhere around 10% of my investable assets and probably somewhere around 5% of my overall assets. I think that it's important to not necessarily. I would say I'm as exposed to gold as I should be at 10% and that would be my max. What would you do?

Clem Miller: 28:41

So let me say first that I totally agree with your all inclusive view of what your assets and income should be. And you know, like you, I look at my annuity streams and say, well, when I look at it as sort of a waterfall, I think first, well, I've got these annuity streams coming in and then what do I need to use from my other assets, my investment assets beyond that? And so I definitely look at things from that perspective. I also think of real estate value as being a part of assets, certainly agree with that of gold itself.

Clem Miller: 29:31

Um, I am relatively, um, relatively unafraid of hyperinflation. I don't think we're going to get hyperinflation. I think that I'm pretty optimistic as far as the global financial system remaining in place, despite, you know, geopolitical. I don't think we're going to have a war between the great powers. I think none of the great powers really wants to have a war. There could be some regional conflicts, like Ukraine, you could have Taiwan, but I don't think there's going to be a major global war that's going to kill the, the global financial system. So I'm not terribly, uh, concerned about that. I am, you know, I am aware of, um, you know I'm mindful of some of the things I mentioned about gold investments, uh, not necessarily being all that protected from from government expropriation. That's sort of driving some of my thinking about gold.

Clem Miller: 30:36

But you know, I don't look at gold as something you know. Gold is a diversifier, no question about that. It is relatively uncorrelated to other investments, especially equity investments, in a portfolio. But the reason it is uncorrelated is because it doesn't generate an income stream and I know what you said about fixed income at close to zero yields a few years ago, a couple of years ago at this point. But the fact of this lack of correlation with equities and other assets is because it doesn't generate income and as I think ahead and as I get older, I want to have more income and I'm just not going to get the income from gold.

Steve Davenport: 31:44

So those are some of the things that you have to hire somebody who uses auctions to get an income.

Clem Miller: 31:50

Yeah Well, maybe that's a way to do it. So, yeah, well, maybe that's a way to do it, but these are some of the thoughts that enter into my thinking about gold.

Steve Davenport: 32:03

Thanks, clint, I think. Thanks for the whole discussion today. I think it was a thorough analysis and I think we probably need to think about what other assets, because I had a client call me and say that they were pitched on a ski lift up in Park City, that a person was telling them that commodities are the place to be because there's going to be so much chaos and everybody needs commodities. I think of gold as the tip of the commodity spear, but maybe we should have a discussion about some of the other commodities and whether they spear. But maybe we should have a discussion about some of the other commodities and whether they will provide a better overall hedge to some of this inflation discussion. But thanks everybody for listening to the podcast and please like and share. We enjoy being here and doing this for you and we hope you find it useful. Please DM us with any ideas. Thank you.