Bullion and Stocks As Long Term Investment Vehicles
There is no question as to the superior value of stocks as investment vehicles versus the appeal of using bullion for this purpose. There is a very good reason why most people look to load up on stocks and use stocks as their primary investment when they are looking to build long term investment portfolios, because historically, no other asset even comes close to stocks as far as accumulating long term value.
The stock market has tended to significantly outperform inflation over its lifetime, and while this does not necessarily mean that this will continue on indefinitely, and especially does not mean that this will be the case over a given period of shorter duration such as a decade or two, stocks are as good as it gets when it comes to a buy and forget about it strategy goes.
Bullion, in comparison, does tend to at least keep up with inflation over the very long term, but barely. While this is certainly a plus, in comparison for instance with just burying your money in the back yard, where you will lose the full measure of inflation, or putting it in a savings vehicle, where you will capture some returns but of a lesser value than inflation, bullion is not considered a primary investment vehicle like stocks are.
Even though bullion does outperform savings vehicles, it does so in a way that is far more volatile, and the hallmark of savings vehicles is their stability actually, the opposite of volatility. Bullion tends to be even more volatile than stocks though, and can go up and down in value pretty significantly over a decade or two, and volatility is not something that long term investors embrace.
On the whole, using stocks and not bullion as one’s primary investment vehicle when seeking to take long term positions in something makes perfect sense, although this does not mean that bullion investing does not have its place.
The strategy that is most often used is to hold a certain portion of one’s portfolio in stocks and a certain smaller proportion in other assets such as bullion, to provide more diversity to one’s portfolio and to also seek to hedge against risk.
This is the only real reason you would want to use this diversification actually, given that bullion does tend to underperform stocks over the very long term. In shorter time frames though, this can differ, especially when people flee out of stocks and into other assets such as bullion, which is a strategy that institutional investors generally use than individual investors, where individuals are much more prone to not vary their strategy much and just sit back and take the punishment during these times.
How Inversely Correlated are Stocks and Bullion?
Because a lot of money moves out of the stock market and can move into things like bullion during stock market bear markets, a lot of people assume that stock markets and bullion prices are quite inversely correlated. So they may think that bullion may therefore serve as a good general hedge against stock market positions, where a certain percentage, and perhaps a significant one, is held in bullion at all times for hedging purposes.
This isn’t just an incorrect view though, it’s very incorrect, as these two assets are not inversely correlated generally. When we look at the numbers here we see a completely different picture being painted. Over the last 45 years for instance, where a correlation score of 1.0 means that two assets move together, -1.0 meaning that they move in completely opposite directions, and a score of 0.0 means that they move completely independently, the correlation between gold and the stock market has been measured at 0.06, very close to completely independent.
This score does vary depending on the circumstances of course, with some time periods producing a higher negative correlation, but on the whole, this suggests that bullion has very little value overall as a way to hedge stocks.
When we add in the way that bullion tends to underperform stocks over the very long term, we may wonder why anyone would even consider using bullion as a hedge over this very long term period. The truth is that while this approach has little value if any, there are certainly situations where you can very effectively use bullion as a hedge, just not as a once and done and ignore from here strategy.
In other words, a good strategy for hedging stocks with bullion is going to depend on how each of these markets are behaving at any given time, not how they have behaved over the last 50 or 100 years or whatever. A sound portfolio management strategy seeks to take into account all relevant facts, and how assets have performed over a given time frame and how they can be expected to perform over a given time frame are pretty relevant and important facts indeed.
Looking at Stocks and Bullion Independently
Especially since stocks and gold move rather independently overall, we should be looking at whether we want to be in each of these markets, and the degree that we should want to be in them, quite independently of one another. This is even the case during stock market dives, the point in time where we’d be most likely to assume a negative correlation and act in concert with what we may believe may happen.
This may or may not be the case in practice though. There are periods where the two may decline together, for instance during the big bear market in stocks in 2008-2009, where if someone just jumped on gold for instance they would be just exchanging one form of punishment for another. Running from one thing that’s falling a lot to another which is falling a lot didn’t work out so well.
What’s most important here to realize is that a lot of people held bullion to seek to protect them against this very type of event, but this did not serve to provide much of a hedge at all even in such an extreme condition. The drop in the two assets, dollar wise, was actually strikingly similar during this time.
This does not mean that there aren’t times where this is a good move, where the stock market dives and bullion may be doing much better, but it depends, and ideally this should not be approached like blind man’s bluff.
Given that there is a price to be paid for this general hedge, in reduced expected return, looking to hedge blindly like this is not anywhere near what it is cracked up to be. Investors tend to rely more on platitudes that seem to have merit on the surface like the idea of mixing your assets this way but never really think about this strategy nor examine it much beyond that, nor do the people advising them do much thinking about this stuff generally either.
There are times where stocks are a better investment than others, and the same is true of bullion, and bullion can perform very well at times in fact. During some bear markets in the stock market, bullion can be a very good choice.
Even though overall, over the last 100 years for example, stocks have well outperformed bullion investments, this does not mean that this is the case during a given shorter term period, such as 5 or 10 or even 20 years.
Coming Up With a More Ideal Approach to Investing in Both
When we invest in something, we do so with an expectation of accumulating value over time. Ideally, we should be looking to be in investments where we may expect this performance to be to our benefit. In times where performance is expected to be less, we should be looking to be putting our money in something else, including just holding a good part of it in cash should conditions warrant.
When we look at the bullion market, there are times where we can see prices rising, some real good bull markets, and the move from 2000 to 2012 is one of these periods, although remaining in the market from there until now would have been regrettable.
The same things happen with the stock market, we have some very nice bull markets lasting quite a while, and we also have some significant bear markets that emerge which can take quite a while to turn around.
If the stock market and bullion market were truly inversely related, or even close to being so, then we could say that holding a position in bullion over time may provide some real hedging benefits. The truth is though, this isn’t the case at all, and it actually does not make sense to hedge stocks with bullion as a general hedge.
However, if we are open to investing in both markets, according to how each of them is expected to perform independently, then this can indeed provide a nice hedge, where some stock bear markets can be hedged against when bullion just happens to be expected to outperform it. In other bear markets, where both assets are underperforming, then this gives us the ability to look elsewhere for our hedges, as it would make sense to do under the circumstances.
So many people are looking for the simplest of solutions when investing, and while there is certainly something to be said for simplicity, we should only be looking to simplify when doing so would be to our benefit, and not look to hurt ourselves or fail to benefit ourselves when this requires some thinking or effort and we find ourselves quite allergic to both.
There are various levels of involvement that people seek with managing their portfolios, and managing them fairly well does not really require a lot of expertise as most people tend to think. This management can benefit from some fairly simple strategies that simply look to avoid some of the bigger stuff, the bigger risks and problems that hold and forget strategies become subject to due to their completely passive nature.
If one is looking to invest in both stocks and bullion, it bears paying attention to both these markets, and look to at least consider how we may best approach them under various and changing market conditions. We may want to be invested in both to certain degrees at certain times but how the assets are performing does matter, and matter quite a bit actually.
This all may require at least some degree of paying attention, and some investors do not wish to do any of this, but if one is looking to improve their portfolios, and one is also up for the challenge, then learning how to do this reasonably well may make sense.
Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.