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Why one of the world’s top hedge fund managers thinks it's time to buy gold

Every now and again, markets undergo a “paradigm shift”. Hedge fund guru Ray Dalio thinks we’re near one now. And he’s buying gold. John Stepek explains why you should, too.

Gold bars in a safety deposit box © Michaela Handrek-Rehle/Bloomberg via Getty Images
Time to tuck away some gold

Gold bars in a safety deposit box © Michaela Handrek-Rehle/Bloomberg via Getty Images

Ray Dalio is the founder of Bridgewater, arguably the world's most successful hedge fund.

He's just put out an interesting piece on "paradigm shifts" in markets.

To cut a long story short, markets go through long periods of behaving in a certain way. Once this behaviour becomes unsustainable (because people get used to it and start taking it for granted), market behaviour often flips.

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In other words, you get a paradigm shift.

Why does this matter? Because Dalio reckons we must be getting pretty close to such a shift now.

Preparing for a paradigm shift

Dalio points out that each decade since the 1920s (at least) has had a different investment "paradigm", which often creates the conditions that give rise to the big shifts. To be clear, this is based on the US experience, which is not universal by any means.

So the boom days of the roaring 20s, gave way to the depressionary era of the 1930s. And the boom of the 60s, gave way to the stagflation of the 70s, which created the conditions for the long, secular decline in inflation and interest rates that began in the 80s.

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Since the post-2008 era, we've been in a "reflationary" paradigm (at least when it comes to asset prices). But Dalio is concerned that this has taken us to a point where central bank policy is running out of steam.

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By driving down interest rates and boosting asset prices, central banks have effectively pulled forward returns from the future. As we all know, one of the biggest influences on future returns (after costs) is valuation. If you buy stuff when it's expensive, your long-term returns will be lower than if you buy stuff when it's cheap.

Dalio's point is that eventually central banks will push asset prices up to the point where future expected returns are no better than those on cash. The closer you get to that point, the less inclined investors will be to buy those assets because the expected returns simply won't be appealing enough, regardless of how low rates are.

In turn, if you can't convince investors to continue buying things like government debt with negative yields, then you have two choices. You either allow interest rates to rise (which would be painful for an awful lot of people and countries), or you hold interest rates down and print money to pay off the debt, weakening your currency in the process.

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Either way, bondholders get stiffed.

So what can you own at a time when trust in paper assets and the like is falling? (And this is before we get on to the more general lack of trust in society, between the wealthy and the less-well-off).

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Well, Dalio reckons that it all means that the assets that will "most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant I believe it would be both risk-reducing and return-enhancing to consider adding gold to one's portfolio."

The trouble with timing

So there we go. My colleague Dominic has been talking about the need for a "new narrative" to get the gold bull market rumbling again, and it looks like the great and the good are working on one.

The big question, of course, is when does this all happen? Aye, there's the rub.

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Dalio's outline is quite an elegant schematic. And it's a truthful model of how trends work they keep going until they become so exaggerated and top-heavy that they flip over and you end up with something approximating the opposite of what everyone's grown used to.

But it's too "big picture" to help you out in terms of timing when the great paradigm shift will come about, as Dalio himself acknowledges. It's also worth noting that even someone with Dalio's experience, vast resources, and genuine interest in all this stuff, still can't get it right all the time.

His "Pure Alpha" fund the one that's meant to ride all these macroeconomic waves lost nearly 5% in the first half, according to the FT, which is pretty weak given that this has been an incredibly strong year for asset prices in general so far.

I don't think his clients will be that bothered, given that the fund made nearly 15% last year in a massive dud year for markets, but still it shows you that this stuff isn't easy.

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The other option which is the one that most of us normal mortals need to follow is to have a diversified portfolio. There are lots of ways to diversify a portfolio, and it's easy to get tangled up in all the different categories.

I like to keep things relatively simple most of us are not running the Yale endowment fund, after all. At an overall asset level, you've got five buckets: equities, bonds, property (which is really a hybrid of the first two), cash, and of course gold.

Overall, these five buckets should behave differently to one another in different economic conditions. In other words, they give you the benefits of diversification.

How much you then put in each bucket, and exactly what you fill each one with, is up to you. A lot of this depends on your time horizon (the more time you have, the more volatility risk you can afford to take). We throw out lots of ideas both here and in MoneyWeek magazine (subscribe now if you haven't already).

But if you don't already own any gold, then I do think that now looks a decent time to add that diversifier to your portfolio. (Just to be clear, I mean gold specifically gold miners, which I also quite like just now, should be viewed as a spicy part of the equity component of your portfolio.)

If you want to learn more about asset allocation, diversification, and their roles in building a long-term money pot that you'll be able to fund your retirement with, then don't miss our event on the evening of 9 October "Do you have a Wealth Plan?" MoneyWeek's David Stevenson will be talking to Charlotte Ransom of challenger wealth manager Netwealth and The Week's City editor Jane Lewis about the best strategies for generating an income and designing the ideal retirement for you. Snap up your ticket here.

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