Updated September 11, 2023

The Role of Gold in Modern Portfolios: An Examination of Its Relevance and Utility

There are few hard and fast rules when it comes to how a portfolio must look. Sure, younger investors should tilt their allocations more toward risk-on areas, like stocks, via a diversified macro strategy while retirees often own bonds for their perceived safety, but some asset classes garner much attention and debate compared to others. Gold is a timeless symbol of wealth, though it has become controversial from an investment point of view.

Gold’s Use Cases

Gold and other precious metals have been seen as a store of value and unit of exchange for thousands of years. It has preserved wealth through periods of war, economic turmoil, and political instability. In more modern times, it’s said that an ounce of gold should be able to afford a decent men's suit. As dated as that comparison is, the yellow metal has kept up with inflation over the years plus about a 1% annual kicker, on average. But should you devote part of your portfolio to gold? There are several reasons why we think now is an ideal time to do so. 

Why Owning Gold Today Makes Sense

For starters, the economic landscape both at home and abroad is particularly precarious today. The US government runs annual deficits that top $1 trillion while our total national debt has quickly surpassed $30 trillion (on its way to $40 trillion and beyond) – and there seems to be no end in sight to its epic rise. Is a fiscal crisis brewing? Possibly, and we see inklings of it every so often on Capitol Hill in the form of showdowns over the debt ceiling and looming government shutdowns. 

Critics argue that back and forth among politicians is nothing new and that recent stalemates have not been all that bullish for gold. Still, it’s possible that the Federal Reserve may struggle to raise interest rates without risking government bankruptcy in a fiscal situation known as “fiscal dominance.” At some point, the amount of interest paid on our debt will become too costly.

Pay Attention to “Real Yields” For Clues on Where the Price of Gold Goes

Many gold bulls push the reckless actions of policymakers as a reason for making the precious metal part of a well-rounded investment plan. What they might not mention, however, is that gold prices are generally tied to movements in “real” interest rates, or current treasury yields minus the expected inflation rate

In short, when real rates rise, gold tends to sink. When inflation-adjusted yields fall, gold usually shines. Today, since the end of the Fed’s zero-interest-rate policy, real interest rates are back in the black after a sudden surge in real yields from 2020 through 2023. The going price for an ounce of gold has held in there, though. In fact, it flirted with new all-time highs over that span. If real rates revert lower, then gold could break out to sustained new highs. History shows that like many assets, price trends once established tend to persist for many years and through several market cycles.

Gold: A Proven Diversifier During Stock Market Downtrends

Many precious metals, unlike their industrial-metal counterparts, tend to do well in bear markets when stocks decline. During periods of economic turbulence, gold may help stabilize overall returns. Thus, there is a diversification benefit to maintaining a small slice of gold in your investment pie, which gets us back to the topic at hand. 

So, gold can aid overall returns during equity downturns and when expected inflation rises compared to the current level of interest rates. When does gold not do so well? Often when economic optimism is just getting started – that's when stocks sniff out better times ahead and begin trending up and when real rates creep higher. Another thing to keep in mind is that gold does not pay dividends, so there is no income yield along the way.

Why Gold Should Work in the Years Ahead

Our team views the future outlook for gold as promising given ongoing volatility in both the stock and bond markets and after a steep jump in real interest rates. A potential risk ahead for global investors is a sovereign debt bubble that was blown up during the pandemic-era period of heavy stimulus from both fiscal and monetary authorities. Moreover, de-dollarization and geopolitical jitters around the world may auger bouts of volatility which would be bullish for gold given its safe-haven status.

Making Gold Part of Your Portfolio

How much gold you should own is not a straightforward question. A rule of thumb is that it should be at least 5% of an allocation. There is even what’s known as “The Permanent Portfolio” which outlines a strategy of owning one-quarter each of gold, stocks, bonds, and cash. Historical simulations reveal that such a portfolio has underperformed a 100% US equity allocation, but also with much less volatility. You could own it in physical form, but storing bullion can be expensive with large bid/ask spreads and storage and insurance costs. 

Gold coins and jewelry could work, but the same drawbacks apply. Some investors prefer owning shares of gold mining companies, and that can feature enhanced upside during gold bull markets, but those stocks may also underperform in broader equity market crashes. Simply owning a gold ETF is probably the best play – they are low-cost and liquid, and you can easily track them like any other stock or ETF you own.

How Much Gold Should You Own?

The key thing to remember is that no single asset class consistently outperforms all others over decades. Ultimately, the decision of how much to invest in gold should be influenced by your risk tolerance and confidence in gold's prospects. If you are more bullish, then you might allocate a larger percentage (e.g., 25%-30%) to gold, while others may choose a smaller allocation (e.g., 5%-10%).

The Biggest Risk Might be You!

Sometimes, however, the toughest thing to do is to stick with a strategy during the bad times. Here’s what I mean – let’s say there is a 5-year period during which the S&P 500 doubles, small caps perform strongly, and foreign equities even do well. Over that stretch, maybe real interest rates crept higher and bonds provided a decent, though modest, total return. If gold merely traded sideways, that is a major opportunity cost, and you might feel discouraged by owning gold, then sell due to emotion, not logic.

This is known as “decision risk” in industry parlance. It simply refers to how investors do the wrong thing at the wrong time due to the fear of missing out effect (FOMO) or other behavioral tendencies such as loss aversion. Owning gold means you must be prepared to expect periods of its underperformance – that's the price of admission to accessing its diversification benefits over the long haul.

Allio’s Stance: We Are Positive on Gold Over the Coming 5-10 Years

We view gold as an attractive investment today. Central banks are buying up the shiny metal while many emerging-market nations look to trade commodities using local currencies and settle net differences in gold, in keeping with its historical role as a unit of exchange. By 2030, our team believes an ounce of gold could be multiples of what it is today, though folks who run long-only equity mutual funds might disagree. 

From a portfolio perspective, consider this: Equity valuations are lofty, bond yields have delivered about nothing after inflation in recent years, and geopolitical turmoil seems to only get worse each year. That could make the 2020s a rebound decade for gold. While the 2010s was marked by extremely low inflation, muted volatility, a focus on US technology, and deflationary assets, the next decade could be the opposite. Is the Permanent Portfolio going to make a comeback amid higher equity volatility and real assets over paper assets? We assert the pieces are in place for that to play out.

The Bottom Line

After a lost decade for gold, a period in which the commodity failed to rally much and only featured volatility, some critics argue that owning gold is a fool’s errand. We take a different stance. The next few market cycles may surprise investors, with outperformance from other asset classes compared to what led in the 2010s. Positioning a portfolio with, say, a 10% or 15% weight in gold may help limit overall volatility while still helping an overall investment strategy earn solid long-term returns net of inflation.

Ready for your own highly-diversified global macro investment portfolio (including gold)? Head to the app store and download Allio today!