I first added gold to my portfolio in case of a recession (2016), as the value of gold rises during bad times in the economy.
I also own gold as a hedge against inflation (currency debasement).
In this article I’ll explain my reasons for owning gold for recessions and as an inflation hedge.
Gold for recessions
Let’s start with the easy one, why gold works well in a recession.
Gold tends to have an inverse relationship with the stock market, meaning if stocks go down, gold goes up, and vice versa.
In 2016 my portfolio had too much exposure to stocks, a downturn in the economy or worse still, a recession could erase a chunk of my portfolio.
The S&P 500 dropped by more than 50% from its all-time highs in the 2007-2009 Great Recession.
I was not willing to accept that risk with my wealth.
By adding gold, any losses from stocks will be hedged against the gains from my gold.
This is one way to manage risk.
Most investment strategies advise you to hold approximately 5-10% of your portfolio in the gold metal, but do your own research (#DYOR).
I like gold because it is a stabilizer; it is an insurance policy.Kevin O’Leary
I also added silver. Silver offers more risk than gold because it has industrial uses, so can be impacted negatively during recessions.
Why do people prefer stocks over gold?
Young investors fail to understand the role gold and stocks play in a portfolio, they assume both achieve the same thing, so let’s just buy stocks because they go up faster.
When you talk to friends about investing, nobody is going to tell you they hold gold or it’s the hot buy this week.
It’s much sexier to own a stake in Tesla and Netflix than a shiny gold rock.
Don’t get me wrong, I love stocks.
In a health economy, stocks yield an income and offer faster growth than gold.
If you buy a stock paying dividend, you will be paid an income every three months.
On top of the dividend, if the price of the stock increases, you make a gain on the price increase.
dividend + price increase = wealth creation
Dividend-paying stocks are ideal if you want to retire early and live off your portfolio (my goal).
Even if the stock price heads lower, then unless there is a fundamental change in the company, you will still receive a dividend every quarter regardless of price action.
Dividends may not be the only path for an individual investor’s success, but if there’s a better one, I have yet to find it.Josh Peters
As you know by now, stocks can lose more than 50% of their value.
that’s not a risk I am willing to take with my wealth, and that’s where gold comes in.
Gold is the muscle in my portfolio.
It offers me protection against a stock market crash and offers a better return than holding paper money by being a hedge against inflation (explained below).
Gold offers no dividend.
My gold bars don’t have babies every year giving me more gold.
In most cases it costs an ongoing fee to have gold in your portfolio, unless you hold it physically.
In a healthy economy, stocks outperform gold, this is why the allocation of gold is usually in the 5-10% range for most investors.
Some of the world’s best investors do not allocate anything to gold.
I have no views as to where it will be, but the one thing I can tell you is it won’t do anything between now and then except look at you. Whereas, you know, Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money and there will be a lot — and it’s a lot — it’s a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that.Warren Buffet
It’s hard to argue with Warren and he is right, stocks pay income, gold does not.
But when he said that statement, the world was a different place than it is today.
Gold as a hedge against inflation (currency debasement)
The term inflation sounds a lot less scary than currency debasement, which is why you’ll hear the media call it inflation.
Gold and silver wake up during recessions and times of uncertainty as investors look for safety away from the stock market, and in today’s world people are looking for safety away from paper money.
Most people don’t pay enough attention to their currency risks. Most worry about whether their assets are going up or down in value; they rarely worry about whether their currency is going up or down.Ray Dalio
Before we go any further, let’s take a quick look at the graph of the price of gold vs GBP, so we can understand whether the GBP has experienced any current debasement.
I have made notes so you can understand how the biggest price movements came about from 1970-2020.
The first major price jump in gold was during the 1970s depression when inflation rose and the GBP was debased.
It then moved sideways until a few year before the Great Recession 2007-2009.
In 2012 gold saw a decline in price because central banks around the world said they would no longer need to do quantitative easing (QE) also known as inflation, and would raise interest rates to healthy levels.
Higher interest rates are bad for gold, high interest give incentive to hold paper money as you can earn 5% per year by keeping it in your bank.
We know after the fact, in 2020 QE has become the norm and interest rates are heading negative when they should be at 5-6%.
That is a bad sign for the GBP.
The market reacted to this news with gold making all time highs against the GBP in 2019 and 2020.
As someone who wants to protect my wealth, I asked myself what impact will this have on me?
The chart above tells me there is great risk holding too much GBP, because the value of GBP against gold, is in a life-long downtrend, that is worrying.
I would not want to hold a stock that only goes down in price and pays no dividend, so why would I want to hold a currency that only goes down in price long-term and pays no interest?
If holding paper money will negatively impact my wealth, I want to be positioned to be hurt the least, or gain from it if I can.
Here are a few comments from well known economists and hedge fund mangers about current actions:
Gold is money. Everything else is credit.J. P. Morgan
I’m in my 30s and did not understand the history of gold and silver, or the value behind holding it.
Throughout history wealth was gained by either making It, taking it from others, or finding It in the ground.Ray Dalio
Isn’t it just a shiny rock?
I don’t like investing in things I don’t know about because if something goes wrong with the investment, I won’t know how to react and end up making poor wealth decisions.
So I researched gold and silver. It’s very easy to do thanks to the Internet.
I learned that paper money was once backed by gold, known as the Gold Standard (1).
The UK GBP went off the gold standard in 1933, meaning £10 can no longer be redeemed for £10 worth of gold in a bank’s vault.
Before 1933 you could go to any UK bank, and they would give you gold for paper money.
That’s how banks got consumers to use money, because it was backed by gold, and trading paper is a lot easier than gold nuggets.
Think of paper money as a ticket to redeem gold, if you cannot redeem gold with your paper then the paper has no value.
In 1971, the USA went off the gold standard, which is to say a $10 paper note was now backed by nothing but a belief in our minds that someone would accept it for goods or services.
Gold has intrinsic value. The problem with the dollar is it has no intrinsic value. And if the Federal Reserve is going to spend trillions of them to buy up all these bad mortgages and all other kinds of bad debt, the dollar is going to lose all of its value. Gold will store its value, and you’ll always be able to buy more food with your gold.Peter Schiff
Before 1971, gold was money in the USA, and paper money was just an easy way to transfer gold using the banking system.
I dug further back and found gold has been used as real money during human history for over 7,000 years (2), including the last 3 empires (the British and Dutch, the current being the USA).
Did you know that in 1933 it was illegal to own gold, and the government could confiscate it from you in the USA? (3)
Since 1971 when paper money was no longer tied to gold, the price of gold has been in a life-long uptrend.
This is because gold is a hedge against inflation, there are many ways you get inflation, printing money is the fastest way.
Here’s a graph of the price of gold against major paper currencies from 1850-2020:
To me it was pretty clear at this point that gold holds wealth a lot better than paper money, and instead of holding paper money, I should actually hold gold over a long time periods.
I cannot think of another asset that has as much history as gold as the use of money.
However, my personal experience with gold is far from it being used as money, here’s the Ray Dalio quote from before:
He is right, it’s never happened in my lifetime!
Gold is money in Asia – and just a shiny rock in the West
I’ve spent over two decades in England, and everything I’ve bought has been by using paper money.
As far as I was concerned, paper money is real money, and it still is as long as people accept it.
In the West, the idea of gold as money is not an accepted concept.
We view it as jewelry for rich people and a status symbol of wealth.
Living in Thailand for over a decade and traveling Asia, in the East, the culture is different and many have a portion of their wealth in physical gold.
I’m of Indian descent and every Indian family owns gold. It’s usually passed on through the family and is the last thing they will ever sell.
It passes through the family because that’s how wealth is transferred (gold is a store of value). The belief is that gold only goes up in value over macro-time periods (decades).
This is a thousand year tradition that goes on today.
The same is true for Thailand, gold shops in Bangkok are like Starbucks, there’s one on every corner:
This trend is not only limited to India and Thailand – most of Asia also follow the same belief.
All the low-paid construction labor jobs in Thailand are filled by Burmese migrant workers, and as they are unable to get a bank account, many hold their wealth in gold jewelry.
I see them walking around with thick gold chains worth a few thousand dollars on their necks and gold rings on their fingers. They keep their wealth with them at all times.
There’s also a nice article in MoneyWeek from 2015 discussing the different attitudes towards gold between the West and East.
I never thought of gold as money, but living in Asia my views.
To prefer paper to gold is to prefer high risk to lower risk, instability to stability, inflation to steady long-term values, a system of very low-grade performance to a system of higher, though not perfect, performance.William Rees-Mogg
How gold works as an inflation hedge
What really hit the nail on the head for me for me was to compare the impact of my wealth in terms of gold to GBP, as GBP is the main currency I held.
Gold has increased by 71% against the GBP in 10 years:
I looked out as far as I could go and found that gold has increased 9,751.29% against GBP since 1970:
Paper money gets inflated away over time as there is more debt in the system.
Does it make sense to have £10,000 in a bank if I don’t plan to touch it for 10 years with interest rates at 0.01%? Historically over long periods of time gold has proven to be a better store of value than paper money.
On long-time frames that gold does a really good job of fighting off inflation.
But how can the GBP be losing value against gold when the UK economy is doing great? Its biggest UK stock index, the FTSE100, reached an all-time high in July 2019.
Why are my savings getting crushed by a shiny rock? I had to figure this out.
I learned that inflation is the destruction of wealth, and gold is a hedge against inflation.
Inflation is the increase in prices and fall in the purchasing power of money.
Let me give you an example using paper money.
Let’s say you have £10,000 in your bank account that you don’t plan to touch for five years because you want to save it for a new house, a wedding, a car etc.
With inflation at 2% per year, after five years you will still have £10,000 in the bank because you decided to be a good boy or girl and not to spend a penny.
However, that money five years later will buy you fewer things than if you had spent it five years ago.
Adjusted for inflation, your £10,000 five years from now can only buy you £8,960 worth of goods (2% inflation compounded over five years means an increase of goods by £1,040).
In simpler terms, you lose £1,040 or 10.4% in purchasing power by holding GBP because the cost of living has gone up, and your GBP did not increase with it.
Gold is an inflation hedge, and the more inflation goes up, the more value gold has and the less value paper money has.
Many believe that real inflation is much higher at 5%, which results in a loss of £2,762 or 27.7% of your purchase power in just five years.
WOW – why did nobody teach me this at school, or was I not paying attention that day?
You don’t see inflation when holding paper money because your account shows £10,000, so you think nothing of it.
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.Alan Greendiv
There are many ways you can protect yourself from inflation. Stocks that return a dividend is one way.
Real estate, classic cars, fine art, hard-to-find watches and other hard assets are good inflation hedges as they increase in value as more money is put into circulation.
Gold outperformed the Dow Jones in the last 20 years
A cool fact I came across was the Dow Jones to gold ratio, showing how many ounces of gold it takes to buy 1 Dow Jones stock:
From 1999 until 2020, the Dow Jones has increased in value by 156% against USD.
From 1999 until 2020, gold has increased in value by 1,453% against USD.
If you bought the Dow Jones in 1999 and held it for 20 years, you’d have made 156%.
If you bought gold in 1999 and held it for 20 years, you would have made 1,453%.
This is not to say that gold is a better investment than the stock market (remember you have stocks and gold in a portfolio for different reasons).
If you held Amazon in 1999 until 2020, for example, then your profit would have been 3,451% – more than double that of gold:
Markets run in cycles.
Gold should not be seen as an investment or something you choose instead of stocks, it should be in your portfolio to store your wealth over long periods of time.
Is silver a good investment, and is it better than gold?
Silver, like gold, does not make baby silvers, provides no dividends and comes with the same storage costs as gold.
For over 7,000 years, silver was a store of value and money.
Today, silver has lots of industrial uses. It’s in batteries, LED lights, alloys, RFID, nuclear reactors, solar panels etc.
Silver is more volatile than gold because it’s used as an industrial metal. This causes greater price movements in both directions.
I like silver, as it’s way off its all-time high (I like to buy low, sell high), and if gold keeps moving higher, fewer people are going to be able to afford it, and they will flock to silver. All this has happened many times over in the price of silver.
I don’t hold nearly as much silver as I do gold and have gold to silver somewhere in the ratio of 2.5:1~.
What is my plan with gold and silver?
My gold is doing what it’s supposed to do during times of market uncertainty, which is to hold its value and protect me against inflation.
I will keep some of my gold for retirement, as history shows that if you hold gold long enough (decades), the price of it increases over holding paper money.
In the short term (1-5 years), if price actions start to reveal that the markets are coming back to life and entering a new bull market, I will sell some of my gold for stocks and other assets.
If we slip deeper into recession, my gold won’t be going anywhere.
I am not a financial advisor or tax professional and hold no formal qualifications in this area. This blog is strictly for entertainment purposes only. Please speak to a certified financial expert if you’re looking before making any investments.
Do you have any questions about gold and silver during a recession or its role in my portfolio? Please leave a comment below.