Suddenly, Gold Isn’t Looking So Solid

A  RICH man carrying a heavy bag of gold coins set sail on a voyage, but his ship ran into stormy weather. Before it capsized, he attached the bag of gold to his waist and jumped overboard. He sank with his fortune, never to be seen again.

“Now, as he was sinking, had he the gold? Or had the gold him?”
The English critic John Ruskin wrote this parable more than a century ago, but it raises a question that investors may wisely ask today. Many people have tied their portfolios, if not their very lives, to gold. Yet after the wrenching sell-off and burst of unusually high volatility in the commodity markets this month, should gold and other commodities even be a part of a typicalinvestment portfolio?
Although gold is certainly alluring, the answer isn’t simple.
That gold has been wildly popular — at least until commodity markets plunged — is indisputable, and not just because of its gleaming beauty. It served, after all, as the immutable standard of the global monetary system until the 1970s, a status that has helped give it a certain appeal in an era of wildly fluctuating financial values.
As a measure of gold’s acceptance as a mainstream investment, a gold exchange-traded fund — SPDR Gold Shares, offered by State Street Global Advisors — was the second-most-popular E.T.F. in the United States on April 30, trailing only State Street’s flagship, the SPDR S.& P. 500 fund.
But despite the yellow metal’s sometimes mythic appeal — well documented in Peter L. Bernstein’s classic, “The Power of Gold,” which recounts the Ruskin parable — it is in many ways now just another commodity, like oil, silver, wheat or pork bellies, subject to the vagaries of the markets and, recently, to an extraordinary level of volatility.
It has been behaving much more sedately than its sister metal, silver, which has lost more than a quarter of its value this month, after rising nearly 400 percent since October 2008. But gold has not been a paragon of stable value. It has dropped more than 4 percent this month after more than doubling in value since October 2008.
Which brings us back to the question: Does it make sense for a long-term investor to join in this jolting race?
Leading asset management firms provide very different answers. T. Rowe Price and Fidelity, for example, include allocations of gold and other commodities in their target-date mutual funds — standard portfolios that are intended to be all an investor needs untilretirement or later. “We think that in moderation, in a well-diversified portfolio, getting exposure to what we call ‘real assets’ is useful,” said Richard Fullmer, an asset allocationstrategist at T. Rowe Price.
But Vanguard does not include gold or any other commodity in its target-date retirement funds or any other core funds. For a basic portfolio, it considers them superfluous and highly volatile.
“We recognize that some people may want an exposure to gold for their own reasons, and that’s fine if they do,” said Fran Kinniry, principal at Vanguard’s Investment Strategy Group. “But we’ve found that for the typical investor, you can get all the diversification you need without including any commodities at all.”
In a strict sense, commodities may not even be an investment asset class , because they don’t produce any cash flow or earnings or dividends. That’s the view of Gary P. Brinson, a scholar and veteran strategist based in Chicago.
“A bar of gold is just a bar of gold,” he said in a telephone interview last week. “It doesn’t do anything. There’s a market for it, sure, just as there is for, say, a work of fine art, and if you buy and sell at the right price, you’ll make a profit. But if there’s no cash flow, no dividend, no earnings, how do you calculate its intrinsic worth?” Answer: “You can’t. It’s not that kind of an asset.”
In the 1980s and ’90s, Mr. Brinson did path-breaking research on the effects of asset allocation on portfolios. In two papers in the Financial Analysts Journal, he and several colleagues found that broad decisions about asset classes — which to hold and in which proportions — accounted for more than 90 percent of a portfolio’s performance.
He concluded that eight asset classes — none of them gold or any other commodity — were all that an investor needed. For a model “moderate risk” portfolio under normal market conditions, he said in the interview, those eight and their allocations are: stocksfrom developed markets, 49 percent; emerging-market stocks, 6 percent; investment-grade bonds from developed markets, 25 percent; emerging-market bonds, 2 percent; high-yield bonds, 3 percent; commercial real estate, 10 percent; and private equity andventure capital combined, 5 percent.
All but the private equity and venture capital portions can be bought through low-cost index mutual funds or E.T.F.’s.
Is there any use for gold and other commodities in a diversified portfolio? There might be, he said, if you view them as a form of insurance against a specific risk and if the price is reasonable. Gold might be seen as a hedge against inflation, he said — although it has underperformed since 1980. It might also be viewed as a hedge against a decline in the value of the dollar, but at gold’s current level, he said, “you’re paying a very high price” for it.
Mr. Kinniry of Vanguard pointed out that stocks and gold had both been negatively correlated with the dollar — meaning they have tended to rise when the dollar has fallen. But since 1985, the negative correlation of stocks has been greater, and stocks have also provided a greater return. In short, an allocation to international stocks would have hedged better against a dollar decline, with much lower volatility.
ONE argument for putting up with the volatility of commodities like gold is that their long-term price trend is upward. That’s the case made by Joe Wickwire, who manages the Fidelity Global Commodity Stock fund and the Fidelity Select Gold Portfolio.
“Commodities and gold, from an asset-class standpoint, are in secular bull markets” because of the growth of resource-intensive emerging-market economies, he said. (Mr. Wickwire also said that over the long haul, exposure to commodities was worthwhile for portfolio diversification, regardless of price trends.)
Of course, it’s much easier to discern trends after the fact, and on that score the picture for gold isn’t entirely attractive. It peaked in price in 1980 at $850 a troy ounce. Factor in inflation, and that comes to more than $2,400. After more than 30 years, in other words, an investor in gold would still be operating at a loss, without even counting the cost of storing and protecting the gold.

It’s a beautiful metal, certainly. Is it worth holding? Maybe, but don’t bet your life on it.

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