A quick note on portfolio construction and gold (cc: Professor Mankiw)

Greg Mankiw, a professor of economics at Harvard whose insights and writing I appreciate a great deal, attempted to answer the question of whether “a little gold” makes sense in a portfolio.

By concluding “Sure, keep a little…” he makes a common error.

In my opinion, there is only one answer to the question of gold in a portfolio: You should either hold a lot of gold (25- 50% of total assets) or none at all. “A little” is a waste of time.

After going through the usual historical litany (Roman Empire, etc), Professor Mankiw comes to the conclusion that gold is not such a great performer over long stretches of time – but what the hell, keep it. Probably can’t hurt. He concludes that maybe you should own a small sliver of gold in a portfolio, like two percent. There’s no practical reason to do this, but so many have repeated it over the last five years that it’s become a mantra of sorts. It’s like a shorthand way of saying “See, I’m cautious too.”

On Friday night’s CNBC Fast Money we had Mary Ann Bartels on, a talented and well-regarded market technician who’s just been appointed as the Chief Investment Officer for Merrill’s wealth management division. In theory, she oversees like a trillion dollars. And she basically repeats the same thing that many people like to say: “We still recommend gold as being a hedge within a portfolio.” I asked her what she thought gold was a hedge against – inflation or economic catastrophe. The answer was both. “All of the above, gold really has become a store of value.”

It’s almost like if you’re a chief anything, you have to cover your bases and say that. She has a target price of $1560 for 2014 according to the graphic.

The “store of value” crowd may end up being right, by the way. Gold may race past its all-time nominal high and head to $2000 an ounce. But that’s not the point. Let’s say it really did act as a “store of value.” Great, then what? How would that help you?

What Mankiw, Bartels and many others don’t appear to grasp about portfolio construction is that a “small sliver” of two percent weighted toward any asset class, sector or geography is a waste of time in actual practice. It’s not ever going to have a large enough impact on a portfolio to matter, up or down. It looks good printed on a page and makes you feel diversified, but in real life, it does no such thing.

Let’s say you’re keeping two percent of your portfolio in gold because of a fear of runaway inflation (despite the fact that stocks and real estate have been proven to be a better inflation hedge than precious metals). Should big inflation arise – the really painful, economy-wrecking kind – the other 98% of your portfolio would theoretically drop a hell of a lot more than that tiny gold position would ever be able to offset. It would be like trying to bail your way out of a monsoon with a paper cup.

Let’s say you’re keeping that “small slice” of gold to guard against the crumbling of society or a doom scenario of economic destruction, a stock market crash and the default of US debt along with the devaluation of the US dollar. I’d love to hear why you think having a brick of bullion under your house or a few hundred shares of GLD in a Schwab account are going to help you then. Having a huge stockpile of gold might, should it come to pass that gold would become the new medium of exchange during the chaos that follows.

But you should know that, in this scenario, someone desperate and hungry is going to identify you as being in possession of a meaningful amount of gold. They’re going to round up a crew of equally desperate and hungry people and they’re going to come to kill you for it. No offense, but if it’s your family eating or mine…

A portfolio weighting toward gold is not going to make you the last man standing – perversely, it could, however, make you a human target.

Bottom line: When building a portfolio, don’t think that a sliver of gold at two percent is going to do you any favors in either the hyper-inflationary scenario or in the event of total collapse. Either bet big and load up on precious metals for the worst case you foresee or just skip it entirely.

But don’t think that “the sliver” will help you because it will be meaningless in the context of either an inflationary dystopia or worse.


Mary Ann Bartels on Fast Money here (gold discussion begins at the 5 minute mark):

Can Anything Stop the Bulls (CNBC)

Greg Mankiw’s take here:

Budging (Just a Little) on Investing in Gold  (New York Times)

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