Listen to a gold bug long enough and it seems like gold will always go up in price, and you can never own enough gold. But common sense tells us that “trees don’t grow to heaven” and, likewise, the price of gold won’t go to infinity.
Although we have previously gone over the many reasons why gold is a great investment and a crucial addition to any portfolio, it also helps to take an honest look at when gold didn’t do so great in terms of its price history. Doing this gives us a greater understanding of gold as an asset class, what to expect and why – despite some poor periods – it still stands out as a solid investment.
An Early Wild Ride
Gold advocates will often remind you that “Gold will never go to zero, unlike other financial instruments such as individual stocks or even bonds.” This is true, and will likely remain true given gold’s scarcity and historical precedent as money and a universally recognized medium of exchange. Unless someone figures out how to turn straw into gold, we can be fairly confident in this prediction.
However, while there is great comfort in owning gold, it still technically means that gold could go down in price by a significant amount. So what were some of the worst times for gold?
When the link between the dollar and gold was severed by President Nixon in August of 1971, gold went from an average of approximately $40 per ounce to nearly $200 at the end of 1974, an almost 400% increase!
At this time, President Ford made it possible for citizens to hold gold and bullion once again. If you were someone who eagerly went out and purchased the newly legalized gold for the first time beginning in 1975, you would have seen your shiny new investment’s value cut in half as gold plunged from nearly $200 an ounce to a low of $103 in less than two years.
A Spectacular Bull Run
However, gold then went on to make one of its most spectacular bull runs in its history, reaching a new all-time high of $843 per ounce in January of 1980, from its previous low of $103 in September of 1976. This represented an increase of over 700% in less than three and a half years; annualized, this works out to around 85% per year.
Yet the massive price run in such a short period led to a collapse to $300 per ounce by June of 1982, a more than 60% decline in less than three years. Of course, this entire episode was during the stagflation of the 1970’s where gold took off in the face of extreme inflation, only to be brought back to earth by Federal Reserve Chairman Paul Volker’s very high interest rates.
This shows us that in its early history of trading freely against the dollar, gold had some wild gyrations with drawdowns as much as 50% and 60%. Yet even if someone had terrible timing and purchased gold at nearly $200 an ounce beginning in 1974, holding it through the extreme times of the 70’s and early 80’s still produced a gain of 50% as gold settled down to $300 per ounce.
The Worst Time in Gold’s Price History
The worst time for gold was still to come in terms of its price against the dollar. After its spectacular run and subsequent decline, gold continued to be fairly boring and it gradually declined in price overall.
From $300 per ounce in 1982, gold eventually bottomed out at $253 in July of 1999. In contrast, the Dow Jones Industrial Average racked up over 1,300% in the same period.
Given gold’s bottom of $253 in 1999, and its previous all-time (although very brief) high of $843 in 1980, we can see the absolute worst performance for gold in its entire history: a decline of 70% over a nearly 20 year period.
Lessons to Learn
On its face, this sounds uninspiring. However, first consider that this unfortunate scenario would
require some incredibly unlucky timing and poor assumptions. To achieve this, an investor would have to buy their entire gold allocation on one day that just so happened to be an all-time high, and they would then have to sell all of their gold on a coincidentally unlucky day when gold was at an all-time low.
Most investors spread their purchases over time, and rebalance accordingly, taking advantage of price changes. It is therefore not likely that anyone would realize this full 70% loss.
Secondly, even if an investor did experience a full 70% loss over nearly 20 years, this represents an annualized 6% loss per year. This is certainly a painful time, but if this investor was following something like our 10% recommended allocation toward gold, the total effect on their portfolio would only be a drag of 0.6%.
We have often talked about gold being an alternative currency and more of an insurance policy than a high-performing asset class. Although this 20 year period was the worst in gold’s history, it still ended up ‘costing’ the investor only 0.6% per year, similar to or even less than other forms of portfolio insurance. Ironically, that 20-year low period has been followed by a gain for gold of over 350% from 2000 up to the present!
What happened after this low in July of 1999? Gold went on to a new all-time high of nearly $1,900 per ounce in September of 2011, a 650% gain or just over 18% annualized. This is a perfect example of how we as investors cannot predict the timing of these asset class moves, and why a portfolio balanced between major assets takes advantage of this uncertainty.
The Bottom Line
The bottom line is that gold certainly has its ups and downs, and it would therefore be foolish to put 100% of your portfolio into gold. Yet a careful analysis shows that gold is still less volatile and has smaller drawdowns than the stock market.
Given its non-correlation to other major financial assets, it remains an incredible diversifier and a vital form of portfolio insurance.