Gold Acts as Portfolio Insurance and Protection Again Human Error.

The Time to Buy Insurance is Before Disaster Strikes.

“The time to repair the roof is when the sun is shining” President John F. Kennedy in his State of the Union Address in 1962.

Gold and The Brexit Example.

Last week’s Brexit vote was a known risk. The date for the voting to take Britain out of the European Union was set in late February 2016. Politicians, central bank officials and commentators warned repeatedly that a vote by the British to leave the EU would result in economic uncertainty and disaster. Yet, many investors who listen to and believe in the wisdom of central planners and their acolytes went unprotected into the vote.

On June 23, 2016, a majority of British voters chose to leave the EU. The equity markets crashed globally as soon as it became clear Brexit was a reality. Could anyone honestly claim that the Brexit vote was “unexpected”? Perhaps at best it was improbable, but there was always a substantial probability that Britons might vote to leave the EU.

Thus, a known risk existed and many investors chose to ignore it. Ignoring known risks and not buying available insurance as a hedge against those risks is reckless. Owning some gold would have acted as insurance against a Brexit leave vote. Gold was less expensive before the Brexit vote and cheaper still six months ago – for a reason. Earlier in 2016, risks to the global markets and the Brexit vote were seen as unlikely to have adverse consequences or were just considered too far off to worry about it.

Gold is up 33% against the British Pound in 2016. That is how a gold ‘investor’ or trader might look at it. Put another way, however, the British Pound has lost significant value in 2016. Owning gold in 2016 would have acted as insurance against the decrease in the value of pounds and pound denominated assets. Depending on the size of one’s portfolio and the allocation of gold to it, gold’s gains vs. the pound would have mitigated or entirely eliminated any pound related losses.

In 2016, Gold rose 33% against the British Pound from January -June.

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Gold and Stock Ownership are Not Mutually Exclusive

Some investors eschew gold on philosophical grounds. For example, Bloomberg view columnist, Barry Ritholz argues against gold ownership reasoning in a recent column “I Don’t Hate Gold. I Just Don’t Love It”:

“Perhaps my biggest beef with gold is that it is a bet against human ingenuity.”

Gold is not a bet against human ingenuity. Gold is a hedge against inevitable human mistakes. If you wish to bet on human ingenuity, buy stocks. If you want to protect yourself against human error or human action that may produce bad outcomes, buy gold. Owning stocks and gold and not mutually exclusive.

Not buying gold on the basis of Mr. Ritholz’s rational is the equivalent of not buying car insurance because you don’t believe in betting against the infallibility of other drivers and their impeccable human foresight and skill not to cause accidents.

Neither Car or Home Insurance Policies Pay Interest, nor Does Gold

The tired argument against gold is that it doesn’t pay interest. Considering most stocks don’t pay dividends and a growing percentage of debt instruments have negative interest rates, this is a hollow argument. The gold doesn’t pay interest argument is a weak argument against gold as an investment. Indeed, gold shouldn’t be considered an investment but rather an asset and insurance policy (although it technically fails as an insurance policy as there is not agreement as to which predetermined events require a payout).

Home owners’ and car insurance policies don’t pay interest. These policies are protection against bad outcomes – which is precisely Ben Bernanke’s rational for why people hold gold.

The time to buy insurance is before disaster strikes to protect against known and unknown risks. Human ingenuity may be vast, but human foibles and the capacity to make mistakes are not negated by human ingenuity.

Gold is not ingenious, but it never makes a mistake. For that reason, gold is ideal portfolio insurance.

Further Reading:

Gold and Real Estate Are Not Investments

Gold is the worse investment in the world

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