Why Do The World’s Most Sophisticated Investors Own Gold?
By our estimate less than 1in 1,000 endowments and pensions have allocations to physical gold. The same is true today for HNW client allocations at Credit Suisse, Merrill Lynch, MorganStanley, UBS,Goldman Sachs, BNP … and virtually every major western investment house globally.
Is such uniformity of opinion by these investment houses simply due to how obviously flawed the thinking of gold bulls is today?
That argument hits a brick wall however when one considers the bullish case for gold is being trumpeted by many of the world’s most sophisticated investors and
greatest traders. The names and success of these gold proponents are so extraordinary that it begs
“What are the true motivations for such emphatic 0% allocations by investment brokerages?”
Further given how in the past uniformity of opinion of financial advisors has been a contrarian indicator it also begs the question:
Shouldn’t such ubiquitous negative consensus among investment firms who do not allocate to physical gold be a red alert warning the consensus is wrong?
We conclude that is the case. As Ray Dalio founder of the world’s largest hedge fund succinctly told a room of financial professionals:
“If you don’t own gold, you know neither history or economics.”
The benefit, make that the necessity of a gold allocation, couldn’t be as obvious as Dalio says …
… could it?
The answer lies in the data … and you will see the data clearly suggests gold’s value to
portfolios really is as obvious as Dalio suggests.
The Relevance of Track Records
Isn’t finance supposed to be about track records and data?
About objectivity, not subjectivity?
To date advisors have convinced virtually 100% of family offices to ignore the data that suggests gold deserves an allocation within portfolios. We’ll let you decide if Dalio’s biting judgement applies to these investment wirehouses and their unsuspecting
clients. Before we delve into the reasons why the world’s most sophisticated investors own gold, allow us to pass on a handful of data points that should be very relevant to you and may clash with your prior beliefs of gold if your allocation to date has been 0%:
1) We now have nearly fifty years of data in the modern era during which gold has been allowed to trade freely. In dollar terms, gold has averaged +7% annually over that period. In most non-dollar currencies, gold’s return has been even greater and in numerous currencies in our lifetimes gold’s return over those fifty years is infinite.
2) Gold’s annual return this century has accelerated and is in
excess of 8% in dollar terms.
3) Arguably gold’s greatest statistic is that it has never been rendered worthless unlike virtually any other asset. Further its purchasing power when measured
in common units such as labor has retained its value literally over centuries.
4) In return for this bedrock security that has superseded any government or any other asset in the capital stack for safety, gold has of course underperformed
traditional assets with higher risk profiles such as equities – after all, that is why the world’s largest investment houses channel ~100% of client wealth into these risky assets … right? The data tells a different story. From 1971 through 2018 the period in which gold has been allowed to freely trade, stocks as represented by the S&P500 have
returned 2350% …
while gold has returned 2850%. Perhaps Dalio’s biting criticisms of the ignorance of
professional money managers is beginning to sink in with you?
5) During this period, gold has been negatively correlated to equities, fixed income and real estate, making gold extremely valuable as a portfolio
diversifier alone. We have yet to find an asset with similar stability and a long-term track record that brings such attractive diversification to portfolios over time – if you find one, we invite you to bring it to our attention.
With that historical foundation in place, and your mind opened to
the realization that if you are like most investors you have had a biased and prejudicial view of gold’s
returns and attributes, allow us to consider what the world’s most sophisticated investors say about the metal.
Gstaad Presentation Summary
Investors today should recognize that despite numerous occasions from
years gone by where global fears dwarfed today’s fears … the world has yet to
So, as gold bulls we are not betting on Armageddon appearing as this has thankfully been an overly pessimistic bet.
The world has however seen hundreds of currencies collapse, numerous market crashes, and
countless economic skirmishes … and in virtually all cases wealth has transferred to gold owners in such periods of stress & opportunity. JP Morgan may be history’s posterchild for the opportunities availed investors with gold allocations during times of stress.
We recommend that gold allocations should be comprised of two layers in each portfolio. The first is akin to an insurance layer that is never sold, be the insurance layer 2%, 3%, etc.
The second layer is more opportunistic that may be 0% at times and may be
dramatically more at other times when notable gold outperformance is expected. We underscore that this temporary excess layer of gold is bought specifically to be sold when the world more appropriately moves from uninterested in gold to infatuated with it, a moment that should correspond to when real estate and equities are much cheaper than today.
at other times when notable gold outperformance is expected. We underscore that this temporary excess layer of gold is bought specifically to be sold when the world more appropriately moves from uninterested in gold to infatuated with it, a moment that should correspond to when real estate and equities are much cheaper than today.
1) Gold As The Ultimate Wealth Reserve
Why do the world’s most sophisticated investors own gold today? In complete contrast to the media sound bite that responds “Armageddon,” as has been the case throughout centuries today’s best thinker’s own gold for several attractive reasons.
Foremost among these reasons is that gold is a wealth reserve, a store of
value that has no equal in preserving family wealth throughout the years. If one looks at the purchasing power of gold in terms of constant ounces
(a gold-centric perspective that history suggests is the way to look at finance) thousands of years ago laborers and soldiers were
paid in ounces that would still be sufficient to retain those same services today. Dialing in more recently, gold provided the same wealth preservation over the last century and again in recent decades since gold began trading
freely 50 years ago.
at finance) thousands of years ago laborers and soldiers were paid in
ounces that would still be sufficient to retain those same services today. Dialing in more recently, gold provided the same wealth preservation
over the last century and again in recent decades since gold began trading freely 50 years ago.
Seth Klarman, billionaire founder of Baupost Group that oversees $30 billion in client capital also concluded sovereign currencies were not worthwhile stores of value. He said “because of
… potential debasing of paper money and paper money not being a good store of value, I want some exposure to gold.”
Paul Tudor Jones, billionaire investor of the Tudor Investment Corp went further and spoke of the pending need equity investors will have of gold saying “[gold] will be the antidote for people with equity portfolios.” His comments were focused on the potential extreme drawdown in equity and equity like allocations where an allocation of wealth reserve may prove invaluable. His use of the word “antidote” implies he foresees a potentially deathly repricing of today’s traditional investment choices where gold will prove uniquely and incomparably valuable.
The data supports the view of these uber-successful investors of gold as a wealth reserve.
Over the last century all major currencies have imploded in value vs. gold. This reality repeats if one looks even further back with over 600 fiat currency cases studies all having the same outcome, eventually trending towards worthless vs bedrock gold. Even today’s sole reserve currency, the US dollar, has lost over 80% of its value relative to gold in our lifetimes – and it is the best performer of paper currencies in the modern era.
2) Gold: Protection from Government Policy Errors
Gold’s success as a store of value and wealth reserve is more than sufficient to warrant an allocation among all wealthy investors who should view wealth preservation as their most important task. However, gold has other properties that are also beneficial to portfolios. One incremental benefit is protection from government policy errors. Financial history shows us that when governments print copious amounts of unbacked money it never has been a positive for its citizens. Time and again logic and the rules of finance prevailed as expanded money supply consistently leads to the price of assets increasing in terms of those colored confetti. This proves to be a vicious tax on the productive people in its society robbing them of the rewards of hard work and thrift if they saved in a paper currency. Confetti finance has also consistently triggered misallocations of capital. Today’s cycle has taken this absurdity to a unique level as for the first time in 5,000 years, bankers have used their currencies and
balance sheets to such a degree as to distort finance such that interest rates have crossed into the
This summer in Denmark perhaps the greatest illustration of the worthlessness of today’s paper currencies surfaced as Jyske Bank, Denmark’s 3rd largest lender began offering mortgages at a negative rate. The takeaway is that paper money is so worthless, banks are literally paying people to borrow it. As occurred with the internet collapse and CMO collapse our expectation is that this pipe dream will come to an abrupt halt and send investors scrambling for real assets as we also saw in the financial history classics, Lords of Finance and When Money Dies.
Another massive implication from central bank errors and the subsequent misallocation of capital places the entire life insurance sector in its crosshairs as an
impossible outcome moves towards the unavoidable.
In Switzerland for example where rates are negative looking out 50 years, insurers are conceding they will all go bankrupt. The only question is how long they can stave off the inevitable. Think of how this policy error spills over into the value of gold as a store of value. Each year hundreds of billions of dollars of life insurance are sold. History again whispers to us that such a hedge in depreciating assets (dollar, yen, etc. denominated life
policies) makes little sense through the lens of history. But now we realize these policies are
being sold by companies that realize they cannot stay in business to even repay their policy holders. How much more valuable will this development make gold? At some point as this realization sinks in and insurance owners unfreeze themselves, another wave of capital will begin to look for a secure asset – and there simply is not enough gold available anywhere near these prices to accommodate the shift.
Let’s address however a misunderstanding about gold – Fed Chairman Ben Bernanke was
wrong when he said there isn’t enough gold to have a gold standard for the world today. There is ample gold for a gold standard or to accommodate incremental asset shifts from withering hedges such as life insurance. Gold just needs to be priced appropriately higher given the explosion of money supply.
Speaking to central banker errors, Paul Singer, billionaire founder of $20 billion Elliott Capital observed gold “has stood the test of thousands of years as a store of value and a medium of exchange… it makes a great deal of sense to own gold … while the world’s central bankers are completely focused on debasing their currencies”
Jacob Rothschild of the billionaire Rothschild family also described how
unfit paper currencies are for protecting families from governmental policy errors saying “[central bankers] charge forward with the greatest experiment in monetary policy in the history of the world.”
The data supports Rothschild’s claim that never before have central bank policy errors been so egregious that interest rates crossed the threshold of negative territory. Today $15 trillion of paper trades in this bizarre fantasyland. Specifically, the Fed’s Operation Twist has been an epic success, temporarily decoupling gold’s price from monetary expansion by driving long term bond yields lower and quelching any concerns in the world’s most watched barometer of inflation, namely US bonds ….
At the same time, estimates of the value of all gold globally is only half the value of negative yielding debt. So, before investors even consider allocating away poor credits, overleveraged currencies and money-losing equities, the storehouse of value offered by gold at today’s prices is swamped by negative yielding debt.
3) Gold: A More Attractive Yield Than $15 Trillion+ Of Fixed Income
Offered To You With A Subsidy
A widely cited knock against gold has historically been that it doesn’t yield anything. For the first time in history the cost of carry for gold is less than the cost of carry for trillions in debt. Have investors grasped this?
The Operation Twist strategy borrowed short term money and used the proceeds to buy long term bonds, effectively driving yields from ~4.5% to 2% on the US 30 yr.
At the same time as it was initiating Operation Twist, the Fed reassured investors there was
nothing to worry about – the central banks had the backs of the equity and fixed income markets. With nothing for investors to worry about, equity risk premium fell, catapulting stocks, bonds and real estate valuations towards record levels. The valuations were clearly a distortion as to where free
markets would have priced the assets … and in the case of gold the Fed effectively silenced this potential canary in the financial coal mine. But while Operation Twist impeded short term returns for gold shaking out many weak handed investors, the Fed also did something monumental for gold investors.
Directly as a result of Fed actions today investors are able to buy the uncorrelated metal at a discount to free market value while momentum investors chase the virtuous loop of buying what is working, just as the Fed expected would occur. It will likely be the only opportunity investors will ever have in our lifetimes to buy an entire asset class on a
As it relates to fair value for gold, we see this disconnect also manifest itself graphically (prior
chart “Why Don’t More Western Investors Own Gold”) as the price of gold breaks its parallel path to M2 c. 2011 falling notably while equities enjoyed the benefits of central bank policies. As is true with gold’s role as a wealth reserve, the value of gold’s protection from policy errors in itself is reason for allocations to the metals, but as the world’s greatest investors tell the story gold has additional attributes that deserve appreciation.
4) Gold: Protection from Marco Stress
Another nearly unique benefit of physical gold is protection from geopolitical and macro stress. To this end consider what the world’s most informed are doing. Central
banks, never restricted by Chinese walls as to what other departments of government know, have been buying gold at the fastest pace in modern history. After decades of being net sellers of gold, central banks have bought gold every year for the last decade. In 2018 central banks bought a
record 651 tons. 2019 is on pace to set another record with government purchases up 15% y/y through June.
The buyers have not been obscure nations either but number the world’s most prominent superpowers, Russia and China. China has played its acquisition of gold with clandestine precision and we believe now holds over 20,000 tons on the mainland, dwarfing the US federal reserve that has widely been thought to be the world’s #1 gold owner with 8,000 tones. China has been the world’s largest producer and has been the world’s 1st or 2nd largest importer of gold, yet another remarkable duality we are not aware has ever existed before. This duality as the world’s largest producer while vying to simultaneously be the world’s largest importer of the same asset speaks to how important China clearly believes gold will be in tomorrow’s geopolitics. China has also done a rare 180-degree policy change. Previously China forbade its citizens from storing in physical gold. Now however China has told its citizens that it desires they grow wealthy and that it believes wealth will be measured in physical gold and silver in the future. Since removing the ownership restriction, Chinese citizens have been large buyers of the physical.
Similarly, Russia has amassed gold in recent years, increasing its position among nations to approximately #6 globally while increasing gold as a percentage of its
foreign reserves to 20%.
As it relates to the macro picture for gold, consider also that for years the amount of new gold discovered has been falling…
It has been years since there was a major discovery globally. Further
compounding a tight supply outlook, estimates now suggest it can take 20 years to bring a major new discovery online due to compliance, permitting, construction, etc…
Consider the glaring contrast: At the same time as uber informed China & Russia are aggressively diversifying into physical gold, Western investment managers charged to preserve family wealth, believe that 0% gold allocations are ideal. And while investment firms may deny they believe 0% allocations are ideal, lip service means nothing – investment firms are voting
with their wallets … as are Central Banks.
5) Inflation / Deflation Protection
Another benefit of gold is its effectiveness in times of both strong inflation and the worst deflation, again in and of itself a remarkable attribute of the metal. Rampant price increases of goods and services which historically followed rampant money printing have proven devastating to equities and fixed income. The five years of strongest US inflation led to gold gains of +130.4%, while equities returned negative 12% over the same period. Edging into recession consideration gold has increased an average of 20% during the six recessions in the US since it began freely trading. In the mother of all recessions in the US, the great depression, stocks fell over 80% at their nadir while gold closed the great depression 70% higher as the world supported its value in times of weak economic demand … but increased money printing.
6) Potential Future Upside
Yet another attractive attribute of gold is its potential future upside from
current levels. As cited above, gold has returned a more than respectable 8% this century but the
prospects for it now to potentially accelerate its returns are in place. Consider the words again of Tudor Jones who in the summer of 2019 said that for the next 1-2 years gold offers more upside than any other asset he sees. In his words gold “has everything going for it”. Dalio echoed similar expectations of strong relative gold performance. Dalio and his team of hundreds of analysts expect stocks, private equity, venture capital and real estate will each deliver disappointing returns to over- allocated family offices moving forward. Consider the analysis of Dalio’s firm, Bridgewater Advisors which looked at how unsustainable and how artificial recent stock market performance has been. Their conclusion is that equity returns have been
approximately 3x what they would have been had capital markets functioned without central bank interference and
other factors that are unlikely to repeat moving forward…
With such anomalous recent distortions in capital markets prices, Dalio highlighted that while investors may feel good due to recent financial market returns, current
prices are driving future equity, fixed income and real estate returns far below recent results …
We underscore that because of gold’s historical relationship to equities fixed income and real estate, the opposite paradigm is being put in place for gold owners. Central bank purchases of bonds that have impeded the gold price from moving towards its fair market level are elevating future returns for gold investors, surely another reason why Dalio is recommending a minimum 5% gold allocation for investors.
Dalio specifically stated that uncorrelated gold will have the extraordinary distinction in the future of enhancing portfolio returns vs those other assets while simultaneously reducing portfolio risk. Recall that in the 1970’s when government debts were last a
significant issue, by the time the debt cycle had matured, equity multiples were cut in half and bonds were decimated. Gold rose over 20x in value during the same period.
Could that be “the secret” these great investors are expecting?
Could gold’s potential upside really be so enthralling even though we are discussing the safest asset in finance, one that has proven the ultimate wealth insurance? As you consider the potential upside these titans envision, we can triangulate on the potential trajectory of gold several ways when looking to the last inflationary period of the 1970’s as a guide. If one considers the trough to peak measure of gold during that bull market, and overlay it to the potential upside in this cycle, the metric points north of $6,000/oz. Similarly, if one considers the amount of US money supply relative to the amount of gold held by the US government, gold would need to price north of $6,000 to maintain a similar ratio as in past cycles. A third upside target relates to the inevitable reallocation of western investors in
particular to gold. The consensus among major banks is that gold represents <1% of global assets. HSBC took a stab at the potential impact of a reallocation in today’s world given the effects of QE globally and concluded a 1% shift by western investors’ equity and fixed income allocations to gold would push the yellow metal towards $6,000 as well.
Another potential glimpse as to the upside in gold flows if one looks at inverse of the aforementioned view, namely the price of gold relative to US money supply. When viewed
through this prism, gold/M2 today is at levels only previously seen c. 1970 and 2000. Both periods proved to be inflection points that led to explosive upside and
outperformance by the metal.
7) The Value of Diversification
A seventh consideration for owning gold lies in its extremely valuable role as a portfolio diversifier. Today portfolios are constructed with myriads of assets but little diversification, particularly when one analyzes the performance of traditional portfolios in times of stress.
Vineer Bhansali researched this potential cancer as reported by The Journal of Investing
“the traditional asset-based approach … leads to portfolios that are dominated by equity-like risk, even though portfolios appear to be well diversified… the classic pension portfolio … has 90% of its total portfolio variance driven by equity risk.” [Bhansali, et al. “The Risk in Risk Parity: A Factor-Based Analysis of Asset-Based Risk Parity.”]
And perhaps most infuriating to Wall Street, Research Affiliates and UCLA went a step further in exposing the farce practiced by modern financial advisories who claim their clients have portfolio diversification …
“…A seemingly diversified risk parity portfolio, constructed from equities, commodities, high yield credit, real estate, and bonds … probably provides no better diversification than a simple 60/40 equity/bond portfolio.” [Chaves, et al.” Efficient Algorithms for Computing Risk Parity Portfolio Weights.”]
Michael Burry another of our generation’s most notable investors who prospered during the
2008 crisis added
“The incredible correlation that we’re experiencing – we’ve been experiencing for a number of years – is
Not coincidentally Burry also maintains a gold allocation.
In August of 2019 Dalio took the importance of true diversification to arguably the highest level and penned a white paper entitled Diversifying Well Is the Most Important Thing You Need to Do in Order to Invest Well.
Dalio’s points included the following –
“One of my most overarching principles is ‘knowing how to deal well with what you don’t know is much more important than anything you know’… diversification can improve your expected return-to-risk ratio by more than anything else you can do… Another key building block investment principle is that big losses are not compensated for by big gains, so they should just be avoided at all cost …
He added the following chart and admonition:
Consider the value of gold as a portfolio diversifier in light of Dalio’s admonition above:
10/19/87 – S&P lost 22% in a day. Gold was -2% on paper ($495->$485), and even stronger in the physical.
2000 – The .com bubble imploded causing devastation in the most popular tech investments of the day. Even diversified large cap Nasdaq index was down 39.29%. Gold lost 5% on paper but there was an unusual event that emerged as to why gold’s outperformance wasn’t even better: 2000 marked what looks to be the generational bottom in gold prices – Gold’s low was followed by a 3x rise even as just a small set of investors began to awaken.
2008 – the Dow was down 33%, S&P down 38%, Nasdaq down 40%, and the fad stocks down much worse. Meanwhile gold was up 5% on the year. If one drills deeper and looks at the performance of gold from the period of Lehman Brothers’ collapse on 9/15/08 through the equity market bottom on 3/9/09, equities fell more than 40% while gold rose 17% in the same timeframe.
And as referenced above, in 1929 gold dramatically outperformed stocks, literally functioning as a safety valve for many in the posterchild of corrections, the great depression.
Speaking about the utility of gold’s diversification properties, Sam Zell, inventor of the REIT, bought gold for the first time in his life recently. Why? While Zell spoke to potential upside
ahead, a major reason was to protect his massive real estate fortune. He concluded that no other asset could rival the diversification benefits of gold to his real estate wealth.
Just what is the impact of gold as a diversifier and return enhancer? Consider the data showing the positive diversification benefits on portfolios since gold has begun trading freely:
Additionally, consider the data on the extremely attractive diversification gold has brought to portfolios since it has freely traded:
Source: Palos Harbor
Like a property & casualty insurance professional who sells insurance but
hopes disaster never strikes his clients, we counsel adding gold to portfolios from a similar
vantage. There are three primary differences between gold and P&C insurance, however. The first is that unlike insurance, not only does physical gold exposure not expire worthless at the end of a calendar term, but it has never expired worthless over the centuries. Secondly while the odds of needing P&C insurance statistically are less than 1%, history suggests the odds of needing gold amidst excessive debts are almost 100%. Thirdly while too much stress can cause insurances to go unpaid as underwriters buckle in the face of widespread claims, the more intense stress becomes, so to historically gold has become even more valuable. Again – Obviously we hope market stress never returns, we hope families are never hurt, and we hope that CIO/Family relationships remain harmonious. But contingency plans should not be built on hope.
History says wealth preservation is straightforward. If you’re not going to make money with
90% of your money in risk assets such as stocks, venture capital, private equity and real estate
… you’re not going to make money with 100% of your money in those assets either. Meanwhile a 10% allocation to gold has historically offset wealth compression otherwise suffered during market turbulence. Smaller allocations are also beneficial although historically have not been complete offsets.
Gold allows families to capitalize on tomorrow’s opportunities just like JP Morgan. A little gold allowed Morgan to become the greatest name in American financial history. As Dalio also underscored, a little gold isn’t about Armageddon either – it just shows an awareness of history and economics. We welcome the opportunity to talk with you about manners to allocate to the physical.
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