For Silicon Valley investors that don’t own gold, you may be tempted to buy gold now. Its returns have been stellar, and just about all you hear today are commercials touting gold. Based on past market bubbles, media hype can serve as anecdotal evidence of market tops, and the evidence today would indicate you may be very late to the gold party.
This is not to suggest that you can use the media as a market timing mechanism. But the noise may serve as an indicator to use caution or perhaps rebalance if you do currently own gold or commodities in general as an asset class.
NASDAQ bubble. Gold bubble?
Back in the late 1990s, when technology and growth stocks were forming what is obvious today a huge bubble, all you heard on A.M. radio or CNBC were advertisements for day-trading systems and mutual fund performance. We were bombarded with advertisements by mortgage brokers for low interest, adjustable rate mortgage loans during the mid- to late-2000s real estate bubble. Today, radio and television talk show commentators rant about doomsday scenarios in between mention of a gold sponsor’s toll free phone number. They break for commercial and all you hear is “Buy Gold!” Can anyone hear “gold bubble?”
No one can pick a market top. Gold could easily go higher. Momentum can be a powerful force, and governments worldwide are choking on debt with tax revenues down from recessionary conditions. An Exxon Valdiz-worth of oil is pouring into the Gulf of Mexico every five days from a mile deep. People smell inflation in the air. But, the threat of inflation may already be fully priced into the markets.
The annualized return of the NASDAQ 100 was nearly 35 percent in the 10 years through the month prior to its peak in March 2000. Through mid June, the 10-year annualized return for spot gold is 17.1 percent compared to its longer term average of 9.2 percent since 1971. The problem for gold is its history is defined by spikes in price. From its peak in 1980, gold’s return from April 1980 through Sept. 2006, almost 26.5 years, is -0.01 percent. It is a highly speculative asset class.
Gold doesn’t pay cash dividends like stocks, so your only return component for the metal is price gain or loss only. Precious metals have high transaction and storage costs, so a good way to add gold as a portfolio asset today is through an Exchange Traded Fund (EFT) that has effectively “securitized” gold. As an institutional investor, an ETF can buy and store gold more cheaply than an individual. Precious metals EFTs have been around about five years.
The data going back 10 years indicates gold has been an excellent portfolio diversifier, per the table below. Its correlation relative to stocks and bonds is very low, and its return makes you wish you had only owned gold. A 6 percent allocation of gold to a 60/40, stock/bond, two-asset class portfolio shows interesting results.
The quarterly rebalanced portfolio had superior return and risk while the buy-and-hold portfolio did not. We assumed no transactions costs. It means that a periodically rebalanced portfolio outperforms a buy-and-hold strategy during volatile, non-trending markets, as characterized by the stock market for the period.
So, if you are contemplating buying gold, “rebalancers” will be providing liquidity to you (selling gold), and they are buying stocks today.