What caught my eye this week.

I enjoyed Fire V London’s post this week, although given the title – Feeling Broke – it sounds sort of cruel to say so.

Schadenfreude isn’t really my thing – unless it’s just the whimsically-named accompaniment to a pork schnitzel at the Munich Octoberfest.

No, on the contrary I felt seen.

Fire V London’s article captures a mood I’ve felt too, but I haven’t really shared as much as I might have on Monevator. Which is that while the tiny violins are definitely called for given the genuine hardship so many are suffering in the UK nowadays – let alone in Ukraine and beyond – the past 18 months have felt like a hangover for the ages.

As Fire V London writes:

I no longer feel as financially independent as I’d like to.

Right now, I would struggle to give up earned income; in principle I could probably cope, but on a monthly basis I would feel like I was haemorrhaging cash.

Same bro, same.

Money’s too tight

In not-even-really hindsight, 2021 was truly some sort of Bizarro World.

The pandemic still rampaging around us, millions of people getting paid for literally doing nothing, lockdown anxiety rampant and your neighbours furtive in masks, broken companies going to the moon – and yet our portfolios at an all-time high.

It was bonkers and I kind of miss it.

On paper I’m not even nominally down that much since then. And I’m still well up on where I was when Covid first hopped across the channel (and/or the Nothing To Declare line) in early 2020.

But in real terms – in both the financial sense and the ‘real world’ sense –  it’s a different story.

My monthly interest-only mortgage payments have doubled. Everything from utilities to cheese to a decent bottle of wine costs a lot more. Some of the crowdfunding perks I got for making fun-sized investments in cafes and restaurants in 2018 and 2019 now barely cover brunch. A few years ago they paid for two.

Some of those might sound trivial, but they’re just a few things that came to mind on a list that’s endless.

Like a character revived from the dead to put the spark back into an ailing movie franchise, inflation came back with a vengeance.

Holding back the years

As for my portfolio, the wheels came off in 2022 and I’ve stubbed my feet several times since then as I’ve been running along like Fred Flinstone.

Perhaps we all make money in the same basic ways, but we feel hard done by in infinite variation.

Clearly I’m still in a pretty privileged position. Financially independent if I pay attention, portfolio well-diversified and essentially intact, a home of my own. Although I would argue I saved hard for years and invested wisely to get here, as RIT used to put it back in the day.

My position isn’t entirely a fluke, in other words. The sun was shining for years, and I put something aside for these rainy days.

Maybe that’s why I feel my pride is more wounded than my net worth?

Active investing hasn’t delivered for me for nearly two years now.

And I’d claim that I foresaw what we’ve since been living through back in early 2022 – and flagged up my concerns – but the truth is it didn’t help me much.

I was even talking mortgage stress a year before it was fashionable ubiquitous. My mortgage still doubled!

Harrumph.

Yet I also know we’ve been here before. It’s darkest before the dawn and all that.

As FireVLondon points out, those of us with financial flexibility are meant to be feeling this way:

I also realise that psychology changing over the last two years is Exactly The Point.

This is why base rates are increasing – to increase the cost of financing things, and thus reduce the disposable income left for everything else.

I haven’t found myself existentially exposed by interest rates reaching hard-to-remember levels, but nonetheless my psychology has changed.

True. But this too won’t last forever.

Sooner or later interest rates will have their effect – curbing inflation and probably also economic growth – and asset prices will soar.

Unless inflation has really become unmoored, which I doubt, this will include beaten-down fixed interest, too. Long bonds will leap, for all they look today about as lively as Pete Marsh.

Portfolios will be re-upped.

Weenie’s submarine will be a rocket ship again.

Something got me started

When you’re hiking in the mountains but you’ve been stuck in a valley forever, you just keep on trudging.

Eventually you notice you’re actually stumbling uphill. Shortly thereafter the goal comes back into sight.

Until then, simply try not to lose more height along the way.

Have a great weekend.

How are you feeling two years into The Suck? Let us know in the comments!

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It’s hard not to feel a little head-rush when thinking about gold as an asset class. The yellow metal’s mythical status and cultural cachet is enough to trigger a reflexive “I WANTSSS IT” from your inner Gollum. But then – after briefly checking your eyes have stopped bulging – your rational side wins back control and asks: is gold a good investment? 

Well, is it? The barbarous relic? Beloved of conquistadores, James Bond villains, and pirates with dodgy accents.

Moreover given virtually all the information out there is US-focussed, is gold a good investment for UK investors? 

The Investor previously wrote a passable (his words) introduction to gold as an investment. 

TI cited the common arguments in favour of ownership as:

• A portfolio diversifier due to gold’s low correlation with equities and bonds
• Inflation-hedging
• Insurance against financial collapse, social disorder, and hyperinflation

In this post, we’ll use GBP gold return data to test how well those claims stand up – and which are about as credible as alchemy. 

But for our first stop, let’s examine gold’s historical track record, and whether that tells us anything about the precious metal’s future potential. 

(Note: All returns quoted in this article are real returns – that is, they are adjusted for inflation.)

Gold investment returns

The chart below shows the growth of gold’s investment returns from 1900-2022:

Gold GBP data from The London Bullion Market Association and Measuring Worth.
September 2023.

Over 123 years, £1 of gold transformed into £2.74.

Which translates into a real annualised return of 0.82%.

Hardly worth travelling to the end of a rainbow for. 

For comparison, over the same period the other main asset classes delivered:

• UK equities: 4.85%
• Gilts: 0.91%
• Cash: 0.45% 

Also notice how the graph’s trend line is stoved in by some monster bear markets – especially the 1980-1999 beast. We’ll come back to that. 

But there’s a snag we need to flag up immediately. Which is that, in truth, the returns history of gold is compromised by the heavy hand of State control.

Gold annual returns 1900-2022

The fingerprints of government are easier to see in the next graph:

Prices are effectively fixed up until 1968 by various forms of the gold standard, along with other restrictions including the closure of the markets due to the World Wars. 

The free market is gradually reestablished between 1968 and 1975. After ’68, the market wakes up and gold returns oscillate wildly thereafter. 

The real return fluctuations you see before then are mostly a consequence of inflation (especially during WW1 and WW2) and deflation (during the 1920s to early 1930s). 

The gold price only otherwise unmoors when the pound devalues against the dollar (1949 and 1967), and when Britain exits the gold standard (1919-1925, and from 1931 until the war begins in 1939). 

For our purposes as budding gold investors, the track record before the dawn of the free market era is too distorted by conditions that no longer apply. They should probably be disregarded.  

But naturally enough guillotining the data at any given particular point creates its own problems. 

Goldie unlocks

The free market in gold thawed in stages from:

• 1968 – Gold bars are traded again on the New York market
• 1971 – The US ends the convertibility of the dollar to gold
• 1975 – US citizens are legally allowed to own gold again (a pleasure denied them since 1933)

The restoration of the market unleashed a shock wave of compressed change, as traders attempted to discover the real value of gold. 

Thus three out of four of gold’s highest-ever annual returns medal from 1972 to 1974. 

Notice how those years’ returns rise like skyscrapers above everything else on the chart (except the Burj Khalifa of results, 1979’s 69%.)

Gold returns in the free market era

Any of the three stages mentioned above (1968, 1971, or 1975) mark plausible starting points for gold’s modern track record. 

Start digging from 1968 and we unearth a much more impressive growth story:

Data from The London Bullion Market Association, A Century of UK Economic Trends and FTSE Russell.
September 2023.

Gold turned £1 into £6.80 and notched an impressive real annualised return of 3.5% from 1968-2022.

The precious metal also ran golden rings around its rival diversifiers:

Data from Summerhaven1, S&P GSCI TR, BCOM TR, JST Macrohistory2, JP Morgan Asset Management, The London Bullion Market Association, Measuring Worth and FTSE Russell. September 2023.

1968-2022 real annualised returns (%)

• Equities: 5.7
• Gold: 3.5
• Gilts: 2.7 
• Commodities: 2.7
• Cash: 1.1

However the yellow stuff’s performance is less than dazzling if we start from 1975 – and screen out the unrepeatable gold rush of 1972-1974. 

1975 – 2022 real annualised returns (%)

• Equities: 8.4
• Gold: 1.5
• Gilts: 4.4
• Commodities: 0.9
• Cash: 1.3

The key takeaway here is that starting points matter. Not least because gold aside, the equities, gilts, and commodities results are all way off the historical averages you get from longer-term data. 

Even 50 years’ worth of asset class returns can be misleading if that period is dominated by circumstances that aren’t likely to repeat in your investing lifetime.

For example, would you expect average future returns to look like 1914-1964, with its two World Wars and a Great Depression putting the boot in?

Hopefully not.

Golden ratios

When historical data is ambiguous, we can normally lean upon expected return models to help us form estimates of future performance that take current valuations into account. 

So does a widely-respected expected return model exist for gold?

In a word: no. A few academics have taken a stab but there isn’t an accepted equation we can pull off the shelf to guide our thinking.  

So what can we expect? What factors influence the gold price?  

The greater fool theory

The greater fool theory suggests that when an asset has no intrinsic value, your hopes of making a profit rely on a ‘greater fool’ to buy it from you.  

The question then is does gold have any intrinsic value?  

Infamously, gold doesn’t offer compounding cashflow. Your golden nuggets do not pay out dividends or interest. You’re fully reliant on selling at a higher market price to make money. 

The yellow element isn’t productive like a farm, a company – or even a gold mine.

Gold is just a lump of lifeless metal that some people think looks good dangling from their ears. 

Industrial use accounts for less than 7% of worldwide demand, and is relatively price insenstive. 

Jewellery makes up almost half of demand, though. It is somewhat influenced by the going rate for gold. 

Load of old bullion

You’ve perhaps come across theories that an emerging middle class in India and China will drive demand for jewellery in coming decades? 

But that story has been hanging around for years. Meanwhile, those two giant countries have enjoyed explosive economic growth – yet the gold tonnage required by the jewellery industry is no higher now than in the early Noughties. 

Doubtless, if below-ground gold reserves ran out, that’d do wonders for your holding’s value. But a good third of gold is still entrusted to Mother Earth, relative to the total amount ever extracted. 

And what if Jeff Bezos’ asteroid mining ship ever comes in? That’d dynamite your gold ETC for the foreseeable. 

Mining for gold in space may sound like sci-fi. But think of it as an analogy for any technological breakthrough that increases the gold supply in the future.

Not to mention if the millennials of the ‘prepper’ persuasion ever do swap gold for Bitcoin en masse…

My point is that gold’s fate is obscured by a gauze of contemporary fables. If you want to remain dispassionate, then don’t get wedded to anyone’s alternative facts. 

Fools like us?

The demand inelasticity of gold’s industrial and luxury goods customers means that much depends on your fellow investors. If the world supply of ‘fools’ for gold runs dry one day then your golden goose will be cooked. 

Tellingly, the launch of gold ETFs3 during the Noughties does appear to have boosted the gold price.

According to the academics Erb, Harvey, and Viskanta:

The historical relationship between the real price of gold and the gold holdings of the two largest gold owning ETFs is shown for the period November 2004–July 2020.

As the gold holdings of these ETFs have risen, the real price of gold has risen. These two ETFs’ gold holdings represent the majority of demand for gold by ETF investors. 

The authors go on to speculate that the emergence of these ‘massive passives’ could lead to:

…higher peaks and lower troughs for the real price of gold relative to the experience of the past.

Essentially, they’re saying that the financialisation of gold via ETFs and ETCs has led to it becoming a momentum play. Gold’s star rises when prices take-off and investors pile-on. But they’re as likely to head for the hills if prices sag. 

He who smelt it…

Another hope lies in Cold War 2.0. If you’re a heavy subscriber to What the Government Won’t Tell You style newsletters, then you’ll know all about China’s attempts to diversify its central bank reserves away from the US dollar. 

And actually, there is a nugget of truth to this one. If the figures are to be trusted then China’s gold reserves have doubled in 12 years. But then China is a mite larger than it used to be.

Feverish speculation about a gold-backed BRIC currency adds to the intrigue but – as a reason to be bullish – while I think this story is a crock, it ain’t made of gold. 

Why gold can succeed when equities and bonds fall

In my view then, we have no fundamentals-based reason to expect a positive long-term return from gold. If you agree, then that could be reason enough to strike it from your investment shopping list. 

But given the high level of uncertainty, we should also look at the other reasons why gold may be a good investment. 

For instance, there’s strong evidence that gold works as a useful portfolio diversifier and can succeed when equities and bonds fall.

Here’s how gold responds when global equities take a hit:

Data from The London Bullion Market Association and MSCI.
September 2023.

The chart shows the performance of gold whenever World equities have suffered a 10%+ fall after 1970. 

During 16 equity market slumps:

• Gold beat equities: 13 times
• Did was worse than equities: twice (plus one draw)
• Produced positive returns: eight times

Six out of 16 of those sell-offs were in bear markets: 

• Gold beat equities: six times
• Gold produced positive returns: four times

So gold was really worth its weight when equities were in headlong retreat. Even the least of those bear markets inflicted a -30% knee-drop!

Using a different methodology,4 gold also bested UK government bonds in 11 out of 15 years when equities turned negative from 1970-2022. 

And it helps too – when playing defence as a UK investor – that gold gets a bump when the pound falls against the dollar – as often happens during market strife. 

All in all, the record shows that gold helps diversify risk in a traditional equity-bond mix. 

Gold’s correlation to the other asset classes 

Looking at a correlations asset class matrix can help us assess the diversification benefit of gold. An effective diversifier would register low positive or negative numbers against the other asset classes. 

Indeed, one of the main arguments in favour of gold is that it enjoys low correlations to equities and bonds.

So let’s check if that really is the case: 

Asset class returns correlations: annual returns 1968-2022 (inflation-adjusted)

	Gold	UK equities	Gilts	Cash	Commodities
Gold	1	–0.30	-0.17	-0.1	0.44
UK equities	-0.30	1	0.38	-0.09	-0.26
Gilts	-0.17	0.38	1	0.22	-0.26
Cash	-0.1	-0.09	0.22	1	0.12
Commodities	0.44	-0.26	-0.26	0.12	1

Gold’s correlation to equities and bonds is staunchly negative. This means it has a reasonable chance of pitching up when they’re tumbling down. 

Conversely, that also means gold regularly falls when those assets rise – which will most probably be the majority of the time. 

But while gold may prove to be a drag on overall returns, its typically negative correlation to your investment mainstays can help reduce portfolio volatility. 

That’s especially useful for retirees wishing to mitigate sequence of returns risk. And it’s why small gold allocations are often recommended in investment portfolio examples. 

As an individual holding though, gold is as volatile as equities. It’ll be a wild and often difficult ride. Don’t put money into it if you only like good news. 

What’s that you ask? Just how rocky can gold get?

Gold’s biggest market crash

While gold had a glittering 1970s it didn’t take long for the shine to come off. The gold market began to meltdown from February 1980. It kept sliding for another 19 years. 

Losses peaked at -78%. Recovery took until July 2011. The whole saga lasted a brutal 31 years. 

Of course, gold isn’t the only asset class that can torch wealth on a scale. Witness the UK’s biggest bond crash and worst stock market slump. 

When people say investing is risky – they mean it. 

Hopefully such nightmare scenarios won’t come to pass in our investing lifetime, but it’s still as well to be briefed on what can happen. 

Golden fleeced

For another take on how gold can cut up rough, here’s its real drawdown chart:

The graph shows how far gold dropped from its previous peaks, adjusted for inflation. The white space on the 0% line represents the precious moments after recovery is achieved and before the next plunge. 

As we can see, gold investors got little respite. 

A couple of nasty bears even dumped on the golden age of the 1970s. 

Then came the 1980 to 1999 rout. 

Even if you held on through that – until July 2011’s breakeven point – you only had to wait a few months for the arrival of the next bear that October. Cue a -40% mauling that lasted until December 2015. 

Not to worry though, the pandemic arrived to take every gold investor’s mind off it. The yellow metal duly clawed its way back into the recovery position in April 2020. A mere nine years to breakeven this time!

The point is don’t invest in gold for kicks. Its performance could leave you as regretful as King Midas. 

But enough misery. What about the claim that gold is a good inflation hedge?

Is gold a good inflation hedge?

Sadly this is a myth that’s as persistent as El Dorado. 

Take the -78% real return gold bust we’ve just talked about. The equivalent nominal loss was -46%. If gold was a good inflation hedge, it shouldn’t have shed any additional value in real terms. 

Perhaps that was a temporary glitch? Well here’s gold’s one-year return plotted against UK inflation.

The connection looks almost random. And, sure enough, gold’s annual correlation to inflation is 0.025 from 1968-2022. 

A score near zero means the relationship between the two metrics is almost non-existent. And that’s close to the pattern we see in the chart. 

Finally, here’s the path of the real gold price during the free market era:

If inflation was the only thing that moved the gold price, then the yellow line in the chart above would be level. Gold would be a perfect short-term inflation hedge.

However the fact that the yellow line weaves around tells us that factors other than inflation have caused the price to move. After all, the nominal price minus inflation equals the real price.

This means, at the least, that gold is not a good inflation hedge – because it is non-inflationary factors that will mostly determine the return you receive.

Gold as disaster insurance

The Global Financial Crisis (GFC) was the one true Time of Darkness I’ve lived through when people really talked like the wheels could come off our decadent Western lifestyles. To me at least, the pandemic didn’t even come close for scares from a financial perspective. 

And gold definitely was the ticket during the GFC. Gold ETCs were up more than 70% at the height of the crash. 

People feared QE-induced currency debasement was on the cards. Some thought a hyper-inflationary spiral could follow. 

Which meant gold melt-ups accompanied the post-GFC aftershocks, too. 

Thankfully the cashpoints didn’t close and we didn’t have to brain each other in the streets for Chicken McNuggets. But some investors did still fear the system was teetering and sought refuge in gold. 

Call that anecdotal data. 

But what does the actual data show?

Well, hyperinflation is another catastrophe that gold is reputed to repel. And Erb and Harvey sift the evidence in their paper The Golden Dilemma. Yet the financial golden boys report:

…there is no reason to expect that the real gold return will be positive when a specific country experiences hyperinflation. 

That said, they do think that gold may be less bad than paper assets when you’re paying for bread with a ten trillion note. 

So then, is gold a good investment?

I’ve read study after study, and poured over the UK data, yet I’m still ambivalent about whether gold is a good investment.

For every feature, there’s also a gold bug. 

While I’m attracted to gold’s negative correlation to equities and bonds, I shy away from its lack of intrinsic investing value. 

It’d be okay if there was a reliable demand story that forecast a procession of fools buyers long into the future. But the decisive factor appears to be investor sentiment, and that cuts both ways. 

I think an honest appraisal has to be a shrug of the shoulders. The fact is we could end up choking on gold dust as per the 1980s and 1990s. Or maybe we’ll enjoy golden years like the 1970s or Noughties. 

On the other hand, those two decades were awful for equities (and the Seventies were appalling for bonds). 

And that’s the point about gold – you buy it for its diversification potential. If everything else is going swimmingly then you’ll probably end up loathing your gold. But if it’s not…

Let’s delve more into the diversification side in the next post in this mini-series.

How much difference does an allocation to gold make to an equity-bond portfolio? Perhaps if the risk-adjusted returns are good enough, and gold confers a juicy rebalancing bonus, then the case will be clearer.  

Take it steady,

The Accumulator

1. Bhardwaj, Geetesh and Janardanan, Rajkumar and Rouwenhorst, K. Geert, “The First Commodity Futures Index of 1933,” Journal of Commodity Markets, 2020. [↩]
2. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
3. Gold Exchange Traded Products are ETFs in the US and ETCs in Europe. [↩]
4. Due to the lack of monthly gilt returns data [↩]

What caught my eye this week.

With Storm Babet tap-dancing across the flat roof of my extension, I wondered how I’d spend the windfall afternoon a cancelled trip to the provinces had gifted me.

(Broken British trains, as usual. Flooded, this time).

Obviously I chose to indulge myself by reading the new IFS Green Budget 2023 with a latte whipped up with my infamous espresso machine.

Yes, I know how to party.

Here are five interesting charts from the report, with a few thoughts on each.

1. First some good news: lots of jobs

Two defining images from the TV broadcasts of my childhood are the AIDS iceberg, and long dole queues as three million languished unemployed.

Who says nothing ever gets better? The UK unemployment rate fell to its lowest level since the 1960s at 3.6% in early Spring 2023, although it has since rebounded to just over 4%.

True, there is shade you could throw on this achievement. Many in the UK are poorly-paid. Brexit has constrained the supply of workers, so while unemployment may be lower as a consequence, it’s also pulled down GDP growth. And lots of older workers apparently gave up working during the pandemic, which might be a good thing for some but others will live to regret it.

Still, I’d take those issues over millions feeling like they’re on the scrapheap.

2. Growing nowhere fast

Absentee workers are one potential reason why GDP growth has been so slow to rebound, after the Covid shock.

And while you’d normally expect labour markets to loosen in a sluggish economy, as we saw above they have tightened. As a result wages have actually been rising (albeit only very recently ahead of inflation) despite the foot-dragging economy.

Clearly the GDP break must mostly be a hangover from the Covid disruption: fewer workers than otherwise, people focusing on the less-productive ‘experience’ economy once we could go out again, snarled supply chains, and so on.

Moreover, to look at it glass half-full I suspect this weak performance will take the edge off any upcoming recession – which we’ve been promised for 18 months – if and when it finally arrives.

It’s harder to slump when you’re already slouching.

3. Won’t anybody think of the landlords?

Rental yield isn’t everything, as any How To Get Rich In Property seminar will tell you. The big money is made from capital gains.

And that’s true, but to get capital gains you either need to see more attractive underlying fundamentals – to boost the net present value of your asset – or you need more suckers – to buy off you in the future.

It’s hard to anticipate either in this graph. Bar a blip during the financial crisis, the last time the five-year gilt yield outpaced rental yields was the early 1990s. As interest yields fell, the buy-to-let boom took off.

True, a recession and/or lower inflation bringing interest rates down could change this picture pretty quickly.

But then again in that scenario you’d also enjoy a nice bump to the value of your gilts – and without a broken boiler or a defaulting tenant in sight.

4. Big Government is watching over you

There are many notable things going on in this pretty dispiriting chart. (Do highlight anything you feel is interesting in the comments below.)

However I’ll just note here the far chunkier blocks of fiscal support (the government giveth…) and taxation (…and taketh away) seen in the last few years

While I blame this long Conservative administration for many things since 2016, I don’t blame them for the pandemic. Nor would I particular criticise the big picture decisions they and others made to try to support the economy in 2020 and 2021.

At the micro-level in Downing Street it was clearly a shitshow. But when it came to the grown-up levers of power, every country was working without a rulebook.

I think it’s mostly unfair to blame either Central Bankers or politicians for the subsequent high inflation, for example. Nobody knew exactly what to do, nor what would happen – however it looks with hindsight.

Either way though, the result is that government has been much more directly and visibly impacting household incomes in recent years.

I can’t helping thinking that this will have long-term political consequences.

5. It’s a fix

Many Monevator readers will already know the UK has moved to a predominantly fixed-rate mortgage market, but it’s still striking to see it in a graph like this.

Indeed, given the centrality of property (and property prices) to British economic life, the changeover amounts to something of a quiet revolution.

If you’re wondering why we haven’t had a house price crash yet despite the speedy rise in interest rates, fixed rate mortgages abounding is a big reason.

(Another is that about a third of UK homes are now owned outright, with no mortgage. The third is the tight labour market we saw in the first graph).

Prices holding up despite higher rates is good for anyone who already owns their own home – and frustrating for those who can’t afford to do so.

But home buying aside, the nation’s mortgage holders continuing to remortgage onto higher fixed rates over the next couple years must surely be another dampener on economic growth.

I do also wonder what will happen if rates are cut sharply in, say, 2025? Presumably we’ll see lots of stories about homeowners being ‘stranded’ on 6% fixes!

Something to look forward to…

Anyway, there’s lots more to see in the IFS Green Budget if these are your bag. Let me know if anything catches your eye in the comments below.

And have a great – wet and windy – weekend!

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