October 2024

“Man has the hardest job of all, the job of making decisions on incomplete data.”

Henry Kuttner

When market returns are kind, as they have been in recent times, it can be too easy to forget that bad times in investing will come along at some stage, leading to large and/or protracted falls in value. We hope markets are kind, but without a crystal ball no investor possesses any ability to accurately forecast the ‘whats, whens and hows’ of such downturns.

As your adviser, part of our role is to stress test your financial plan – using what we understand about markets – to ensure that your ability to achieve your financial goals is built on reasonable expectations. We recognise that markets give and take.

One important element of planning for the future is building a reasonable understanding of what a portfolio of investments can deliver. We follow a logical framework to achieve this, illustrated in the graphic below. Following such a framework helps us form central case expectations of future returns. The words ‘central case’ are important here – these assumptions sit at the centre of a wide distribution of possible outcomes.

Figure 1: A logical framework for setting sensible expectations for investment returns

Source: Albion Strategic Consulting

To illustrate the point that returns from stock and bond markets are not expected to come in straight lines, consider the figure below. We take the average calendar year return of global stock markets[1] from the past 30 years (1994 to 2023) – which was an impressive 9.4%, before inflation – and the volatility (a measure of how bumpy the ride was) over the same period of 18%. The figure shows one hundred 10-year simulations with the same average return and same volatility as inputs – perhaps the futures of one hundred alternative universes!

Figure 2: One hundred 10-year return simulations, growth of 100,00

Source: Albion Strategic Consulting. One hundred 10-year Monte Carlo simulations using arithmetic average return of Albion World Stock Market Index (https://smartersuccess.net/indices) from 1994-2023 (9.4%) and standard deviation of annual returns (18%), priced in USD in nominal terms.

Ultimately, an investor won’t know which one of an infinite number of possible paths they are on until after the fact. This is why it is important to make sensible expectations about the future returns markets could deliver, and crucially meet with your adviser on a periodic basis to see which path markets could be taking.

During tough times, this might mean curtailing spending or saving more – part of the role of your financial planner is to advise if and when this might be necessary. The longer one remains invested, the greater the opportunity for shorter term noise to subside and longer term expected outcomes to prevail. A financial plan built on sensible assumptions and maintained through time gives investors the best chance of achieving their financial goals.

Important Notes

This is a purely educational document to discuss some general investment related issues. It does not in any way constitute investment advice or arranging investments. It is for information purposes only; any information contained within them is the opinion of the authors, which can change without notice. Past financial performance is no guarantee of future results.

Products Referred to in this Document

Where specific products are referred to in this document, it is solely to provide educational insight into the topic being discussed. Any analysis undertaken does not represent due diligence on or recommendation of any product under any circumstances and should not be construed as such.

By its very nature, the investing industry is full of differing views on how one ought to invest their hard-earned cash. One of the more polarising debates is whether an investment in gold, physically or synthetically via an investment fund, makes good sense. The debate tends to flare up each time gold experiences a rapid growth in value, such as in the last couple of years.

The Pros

Gold is believed to form during cataclysmic events like supernovae, when massive stars exhaust their fuel and explode, or during the collision of two neutron stars – ultra-dense remnants of supernovae. Due to its lustre and durability, gold has long been prized for jewellery; however, its uses go beyond being just a desirable accessory. It is an excellent conductor, highly malleable, stable at high temperatures and inert, meaning it does not rust. These properties make gold invaluable in industries like electronics, medicine, and aerospace.

Perhaps it is no wonder that humanity has coveted gold for well over 6,500 years[1]. This enduring demand is where the value of gold comes from, and its attractiveness to investors. One impressive quality of gold is that it has retained purchasing power across the centuries. For example, in gold terms a Roman centurion of 2,000 or so years ago was paid broadly the same as a US army captain today[2]. It is this that leads some to propose physical gold as a long-term hedge against the collapse of fiat currency and global capital markets.

Other positives are that gold offers uncorrelated returns to traditional assets such as bonds and equities, providing potential diversification benefits. Unlike many investment opportunities, gold is a relatively simple concept – being a lump of metal with a market value – and is easily accessed via physical purchase or low-cost open-end funds.

The Cons 

As a commodity, gold prices are simply a function of supply and demand. Investors in gold assume that others will desire it even more avidly in the future, with each new buyer hoping that others will follow. If this sounds quite speculative, it’s because it is!

Estimating what to expect from an investment in gold, even over extended periods, is a difficult task. Unlike traditional asset classes, gold produces no income stream[1], it does not pay dividends and usually costs owners to store and insure it. As a result, many assume its long term expected return to sit somewhere near cash, which is underwhelming from a growth perspective compared to sensible alternatives.

The chart below shows the increase in value of 1 ounce of gold from 1926 to August 2024, rising from around $20 to just over $2,500. Investing the same $20 in global equities during this period would have delivered a substantially superior outcome, nearly 50 times the cumulative gain. It’s also important to note that this time frame includes extended periods where government policies, such as the Bretton Woods Agreement, influenced gold prices.

Figure 1: Annual gold spot prices against global equities: 1926-2024

Data Source: Gold.org. Inflation: US CPI. Albion World Stock Market Index. https://smartersuccess.net/indices 

As an Armageddon hedge, investors face a dilemma. Due to its bulk, weight, and the associated costs of storage and management, many opt for synthetic products like gold-backed funds or ETFs instead of owning the metal directly. If the goal is to hedge against a collapse of the financial system, relying on that system to achieve exposure to gold makes little sense. Owning physical gold comes with its own challenges too, such as storage and risk of theft.

Gold proponents may point to inflation hedging as the main attraction, but the evidence is unconvincing. While gold has maintained its value over millennia, across more useful time horizons to investors the results are less impressive. The table below shows that, after inflation in USD terms, gold has yet to get back to its February 1980 high nearly 45-years ago. It also suffered an 83% fall in value over the subsequent two decades – hardly a reliable inflation hedge!

Table 1: Real gold price declines 

Data Source: Gold.org. Inflation: US CPI.

The Portfolio

Like any investing decision, gold has its pros and cons. Assessing whether it belongs in your investment portfolio is the job of our investment committee. Each asset class must fill a specific role in your portfolio and is weighed up against the alternatives. Gold has some favorable characteristics, but you must take something out to put another thing in. Superior options exist, such as shorter-dated high-quality bonds and inflation-linked bonds on the defensive side and developed and emerging market equity as well as commercial property on the growth side.

Table 2: Assessing the role of gold in your portfolio 

As Warren Buffet succinctly puts it:

“If you own one ounce of gold for eternity, you will still only own one ounce at its end.”

(Warren Buffet, 2012)

Risk Warnings

This article is distributed for educational purposes only and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product. Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. 

[1] Whilst gold itself does not produce an income stream, financial institutions may try and claw back some of the storage costs through gold lending revenues.

[1] Smithsonian (2016) https://www.smithsonianmag.com/…

[2] Erb, Claude B. and Harvey, Campbell R., The Golden Dilemma (May 4, 2013). Available at SSRN: http://ssrn.com/abstract=2078535 or http://dx.doi.org/10.2139/ssrn.2078535