The reasons why I believe investors should avoid gold in a recession

Bryan Williams outlines the reasons why he agrees with Warren Buffett on the subject of gold.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

In recent months there has been a steady drum beat of negative news about the world economy. As the litany of concerns grows ever longer, many investors are casting their eyes towards gold ETFs such as ETFS Metal Securities Ltd Physical Gold in the belief that the precious metal may afford some protection.

It is my contention that faith in gold is generally misplaced. Having said that, investors who choose to put their trust in gold are in good company. One of the most successful hedge fund managers, Ray Dalio of Bridgewater Associates, maintains around 10% of his flagship fund invested in gold, citing political and inflationary risks.

In contrast, the most famous investor of them all, Warren Buffett, has frequently voiced his disdain for gold. He counsels investors to keep calm and take a long-term view. He insists that while it is tempting to sell when markets are falling, it is better not to give in to the collywobbles.

The gold story

Beginning with the severe contraction that occurred between 1980 and 1982. This recession was exacerbated by central banks revving up interest rates in order to crush inflation. As expected, the price of gold rose in lock step with inflation and soared from around $200 an ounce in 1979 to reach a peak of around $650 an ounce in 1980. However, during the depths of this slump, the price fell back to about $400 an ounce.

Subsequent to periods of economic growth, there were bear markets in 1990 and 2001, neither of which were noted for raised inflation. Conspicuously, the price of gold barely budged during these downturns.

Many investors remember the rocketing price of gold leading up to the financial meltdown that started in 2007. During those dark days there was talk of a collapse of the banking system and bond defaults. Also, Investors in national bonds faced the real prospect of haircuts on their principal. At that time, the price of gold surged from about $300 an ounce in 2002 to almost $2,000 an ounce 10 years later.

In summary, recent history confirms the hypothesis that gold does rise during periods of inflation and extreme uncertainty. Whilst this is true, history also shows that in the absence of these two factors, gold offers little benefit.

In the long term?

Here, the evidence is unequivocal. Since its inception in 1984, the FTSE 100 has risen around 620% whilst gold has gone up by a fraction of this over the same time frame. If the highest price ever reached for gold is used, then we get to about a 400% rise. Of course, if dividend gains were included for the FTSE 100, the gulf between the two would be considerably greater.

How things look at the moment

Right now, rather than an inflationary environment, there is talk of deflation, which does not bode well for gold. Yes, there is currently a lot of friction on trade issues, but it’s my belief that the present impasse will soon be resolved and these matters will fade into memory. For concerned investors there are some stocks that may offer a measure of reassurance.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Bryan Williams has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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