It’s getting harder for big investors to ignore gold

We like gold here at MoneyWeek. Not just during the bull runs (though we do prefer them) – we’ve always seen gold as a useful diversifier for your portfolio. It’s unusual in being an asset that goes up, or at least holds its value when bad things happen, and most other assets go down.

We’ve grown used to that being a slightly fringe position. But increasingly, it’s not looking as fringe as it once did. And that could have interesting implications for the gold price.

The world’s biggest hedge fund likes gold

Bridgewater is the world’s biggest hedge fund group (you’ve probably seen its founder, Ray Dalio, talking on financial TV at various points). Early last month, a team at Bridgewater put out a short report on gold. It’s bullish.

They point out that we’re in a world where politicians and central bankers are under pressure to print and spend money. When this has happened in the past – such as over the World War II period and in the 1970s – gold has enjoyed “triple-digit [percentage] rallies that dwarf its recent run-up”.

They note that gold’s lack of yield (it pays no income) is less of a problem “when financial assets are offering so little”. You can’t complain about gold paying 0% when a significant proportion of global bonds actually charge you to own them (and they’re not even shiny and nice to look at).

They also point to gold’s use as a hedge against a wide range of risks that are mostly difficult to protect your portfolio against. If you get rampant deflation, gold might see its price fall but it does better than lots of other assets, simply because, unlike equities or corporate bonds, it “is no one else’s liability that could be defaulted on”.

If you get a successful reflation, then that’d be good for equities, but “gold is generally buoyed as well”. And if you get stagflation – a stagnant economy plus rising inflation – then that’s where gold really stands out.

If you’re a regular MoneyWeek reader, you probably know all this. We've made the fundamental arguments for gold several times in the past. They’re all very convincing, particularly right now.

But increasingly there’s another argument to be made, and it’s the existence of this report from Bridgewater that has crystallised it for me. It all relates to another very important driving factor in markets: “career risk”.

What if gold becomes a mainstream asset?

Career risk refers to a very specific risk that applies only to institutional investors and fund managers – people whose jobs depend on how their performance is perceived.

As a private investor, you’re immune to it. In fact, it’s the key advantage you have over professional investors. No one but you cares what happens to your portfolio (convincing yourself of that is another matter, but it’s a fact you should embrace if you want to succeed).

Professionals, on the other hand, are under a lot of pressure. There’s raw performance, which probably matters least. There’s performance relative to the market, which matters more. And then there’s performance relative to your peers, which probably matters most.

In each case, the question is not “how did you perform?” It’s more “how can you justify yourself?”

This is why a stock like Amazon is so popular, for example. I’ve described Amazon as the stock that your fund manager will never get fired for owning. (You can extend this to the FAANGs generally, but Amazon stands out).

You can argue about valuations, but it’s an objectively good company, so as long as you can rattle off something about old metrics being flawed, then you’re sorted. So it’s easy to justify holding it.

More importantly, everyone else owns it too. So if Amazon goes down, everyone else’s performance goes down too, and you don’t look like an idiot.

But there’s an even more crucial corollary to this – if you don’t own Amazon, and it goes up, then there’s a good chance you’re going to underperform, and your investors and your boss will be asking: “Why don’t you own Amazon? It’s a no-brainer! You’re an idiot and you’re fired.” In other words, you don’t have to justify holding Amazon – you have to justify NOT holding Amazon.

As an asset class, gold has always been on the “why do you own this?” side of the ledger. It’s for cranks. It’s a "barbarous relic”, they say (misquoting Keynes as per usual). “You can’t use it at Tesco, not even after the apocalypse” – that’s one I’ve heard a few times. “I’d rather buy ammunition and tins of beans” is the other classic.

Thing is, that’s changing. It’s clear that there’s a desire to hedge against financial chaos and/or potential runaway inflation out there. And history shows that gold is one of the few assets that does an acceptable job of hedging against those things.

Big investors might accept this, but have still often felt justified in ignoring gold on practical grounds. The argument has always been that it’s too illiquid – too small a market to trade in without massively moving the price against you.

Yet Bridgewater takes this argument to task. “In practice, while the gold market is not as deep as equity or treasury markets, there is already ample liquidity for a typical institutional investor to significantly increase their exposure at reasonable transaction costs.”

So you now have this big, influential hedge fund group saying: “you have no justification for failing to own this asset class”.

What’s my point? Increasingly, gold is moving out of the “ridicule” zone. If your client asks, “why do you own gold?”, there are now many respectable arguments to be made and several precedents to point to. In August, for example, the $16bn Ohio Police & Fire Pension Fund in the US approved a 5% allocation to gold to “help diversify its portfolio and hedge against the risk of inflation”, as Bloomberg reported at the time.

What happens when the question becomes: “Why don’t you own gold? Everybody else does.” What happens when the career risk lies in failing to own gold, rather than in owning it?

I’m not sure, but I’m willing to bet that the gold price will have to be a lot higher than it is today.

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