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Gold and Cash: No Match For Asset Allocation

June 12th, 2013

By Matthew Petersen

Stocks are an equity stake of ownership in a specific company. It’s elementary, but with the constant media buzz, we so very often lose sight of the fundamental fact that the companies in which we invest produce products, hire employees, and contribute to the overall economic vitality. However, not all investments produce or employ. Gold does neither of these things. Gold produces no return, no dividend, it’s only worth what a purchaser today is willing to pay with the hopes someone will buy it at a higher price in the future.


The most common fear drivers for investors to purchase gold are to hedge against inflation, or to protect themselves from inflation. This is misguided, because over an extended time frame gold does very little to protect against inflation. If we look at a period of over 30 years, we can see that once the return on gold is adjusted for inflation it barely outperforms inflation. Gold is also very volatile. “Since 1970, its standard deviation has been over 19%, compared with 1.2% for the Consumer Price Index (CPI).[i] By this measure, gold is over fifteen times more volatile than the CPI.”[ii]




















Source: Commodities data provided by Bloomberg. Past performance is no guarantee of future results, and there is always the risk that an investor may lose money. For illustrative purposes only.


Over the years, Warren Buffett (billionaire investor, CEO of Berkshire Hathaway) has been very vocal about his thoughts and opinions on gold. In an interview with Forbes last year, Mr. Buffett provided some insight on the inherent fault with investing in gold:


When we took over Berkshire, it was selling at $15 a share and gold was selling at $20 an ounce. Gold is now $1600 and Berkshire is $120,000. Or you can take a broader example. If you buy an ounce of gold today and you hold it at hundred years, you can go to it every day and you could coo to it and fondle it and a hundred years from now, you’ll have one ounce of gold and it won’t have done anything for you in between. You buy 100 acres of farm land and it will produce for you every year. You can buy more farmland, and all kinds of things, and you still have 100 acres of farmland at the end of 100 years. You could you buy the Dow Jones Industrial Average for 66 at the start of 1900. Gold was then $20. At the end of the century, it was 11,400, and you would also have gotten dividends for a hundred years. So a decent productive asset will kill an unproductive asset.[iii]


Mr. Buffett provides a very poignant argument against the shiny metal rock, which can be summarized as: gold is better to be purchased as a gift or a garment than an investment.


One other very popular haven for fearful investors is cash. The danger of cash, however, is not the physical loss of value, but its purchasing power. As mentioned earlier, gold is often invested in to protect against inflation, of which it does very little, but cash has no protection against inflation. The graph below illustrates the inflation adjusted return the DFA Moderate Balanced Strategy Index, Russell 1000 stock index, and Barclays US Aggregate Bond Index from 1980 to 2013. The red line is the inflation adjusted purchasing power of cash over the same period. In other words, a dollar today cannot purchase the same amount in the future.


























If both gold and cash do not provide a safe haven for investors during turbulent times, how should an individual who is fearful of the future invest? While cash does lose its purchasing power over time, it is prudent to hold a cash position if that cash will be needed in the near future. Academic studies over the past 30 years have continued to shine a bright light on the benefits of asset allocation. A well diversified portfolio that is allocated in equities and fixed income, appropriately to an individual’s risk tolerance, has shown over time to be an investor’s best option for both principle growth, inflation protection, and income generation.



[i] Standard deviation is the statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution.


[ii] Bryan Harris, “Is Gold Worth Its Weight in a Portfolio?”, Dimensional Fund Advisors, Jun 7th, 2012.


[iii] http://www.forbes.com/sites/stevedenning/2012/05/09/why-warren-buffett-wont-invest-in-gold/