We haven't written much about gold over the past year. Since peaking in September 2011 at nearly $1,900/oz., gold has retreated back to the $1,200 range where it has bounced around for the better part of eight months now. The main reason SMI hasn't had much to say about gold is we've largely stopped trying to figure it out. Instead, we now let our Dynamic Asset Allocation (DAA) strategy tell us when is a good time to be invested in gold.
The advantages of delegating this task to DAA were on full display in 2013, as DAA told us to avoid gold all year. As a result, we were able to avoid the stomach-churning descent from $1,700 to $1,200.
The problem with gold has always been that it has no inherent value of its own, so you're always left trying to value it in relation to something else. For example, here's recent analysis saying that, based on gold's historical relationship to interest rates, if the 10-year Treasury rises to just 4% (from its current level of 2.7%), gold would be likely to fall all the way to $800/oz.
Brett Arends reports that gold and silver mining stocks are now at their lowest level, when compared to the actual price of gold, since the data started being tracked in the mid-1980s. So does that make gold mining stocks a good idea here? Not if gold is heading to $800/oz!
Being able to stop trying to make sense of all the confusing information from gold land has been a beautiful byproduct of the DAA strategy. Prior to its introduction at the beginning of 2013, I had owned some GLD and the gold mining mutual fund from our Optional Inflation Hedges. Both of those were sold when DAA debuted. The immediate payoff in 2013 of avoiding a huge loss was great, but even beyond that, the switch helped simplify my portfolio by eliminating that whole area.
I still have a very little bit of physical gold and silver. And I do occasionally ponder whether to increase that as a form of "central bank insurance." See, I view gold as serving two distinct purposes in my portfolio. First, as utilized by DAA, it offers a potential safe-haven and "trading opportunity" purpose. When it is performing well, it can obviously add value to a portfolio, even absent any catastrophe. DAA will allow me to take advantage of that and use "paper gold" — via GLD — to trade in and out of that position. Second, gold serves an insurance role in my portfolio.
This is less about having gold to barter for bread in a post-apocalyptic scenario, and more about recognizing that if things go horribly wrong and we ever have to convert to some other type of currency system, gold typically works as a great preserver of value in those situations. From Arends' column:
Conventional wisdom says that gold is a completely useless investment, a “barbarous relic” from a primitive and bygone age. It serves no financial purpose whatsoever. I have some sympathy with that point of view. But, there again, try telling that to someone in Buenos Aires. I notice that the latest financial crisis in Argentina, and the collapse of its national currency, the peso, has sparked a new bull market in gold down south. Any Argentine with some bullion buried in his backyard has seen its value rocket 25% this month alone in terms of pesos, according to data from FactSet. An ounce of bullion will now buy 10,000 pesos, a record high. That’s compared with fewer than 8,000 a month ago.
Gold is proving to be a very good safe haven in the crisis. And this, I should add, is using the “official” exchange rate for pesos. According to Reuters, in the back streets of Buenos Aires the national currency is now changing hands into foreign currency for as little as 60% of the official rate. In the past five years, the value of gold has trebled when measured in pesos—again, using the official figures. In the black market it has risen further.
In terms of that insurance role, the amount of physical gold I have is quite paltry. But that's a reflection of me thinking (1) needing it in this context is an extremely low probability event, (2) expecting that in the run-up to any such event, DAA will likely tell me to buy into gold in a very significant way (even if it is "paper" and not physical gold), and (3) I think there's a pretty good chance gold may trade at much lower levels at some point over the next several years, in which case I'll probably buy some more coins. That's the thing with insurance, knowing exactly how much to buy is often tricky.
All that said, being able to put all gold decision-making out of mind and just sit tight on a small amount of physical gold has been great. Thank you DAA!