Our view on gold is that it has a place for many investors, depending on their risk tolerance and other investment holdings. But just like any individual security, it should be part of a well-diversified portfolio. While the price of gold has increased a lot lately, an analysis of its long-term performance characteristics suggest that it is a low return, high risk investment. Using the World Gold Council data base, which begins in 1978, we find that investing in gold has generated a return of 5.7% – less than that of money markets. And yet the volatility of gold prices has been significantly higher than stock market volatility. To illustrate the risk of gold, an investor who purchased gold in 1980 would have lost an aggregate 60% of their money as of 2001, and would not have broken even until 2007. This poor return performance has occurred over many market cycles and different economic conditions.
So why even consider investing in gold? The answer is diversification. Gold does well during periods of economic uncertainty. However, gold is not the only investment with this characteristic – nearly all precious metals and most commodities also perform well during uncertain periods. Consequently, we do not believe that gold should be held in isolation, but should be held in a commodity fund that invests in precious metals, energy, and agricultural commodities. This diversification across a broad group of commodities will reduce the risk of investing while providing the long-term benefits of commodity investing.
Not all investors should consider investing in commodities. Our analysis suggests that conservative investors with large allocations to money markets and bonds do not benefit over the long-term from commodity investing. Even for aggressive investors, only a small amount of commodity investing is recommended. This is because over the long-term, commodities are likely to have relatively low returns; their value to an investment strategy is to smooth out the overall risk of a portfolio.