Even a 5% gold holding in a pension drawdown portfolio can reduce its volatility more effectively than government bonds and increase the Safe Withdrawal Rate by up to 0.5% for every 5% of gold held in the portfolio.  A typical UK portfolio of 60% equities and 40% gilts had a historical 3.4% Safe Withdrawal Rate (SWR) after charges. Substituting 5% of the gilt holdings for 5% gold increases the SWR by a full percentage point to 4.4%% and this increases to 5.6% with 20% gold.

This post looks at the potential role of gold for retiree investors in more depth.

Gold is the Marmite of Asset Classes.  Some Investors Love it Others Hate It

Warren Buffet, probably the World´s most successful investor is no fan of gold and has spoken disparagingly about it as an asset:-

“gold gets dug out of the ground in Africa… Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

From a purely rational point of view, it is difficult to argue against this point of view.  There are few asset classes that don´t produce a tangible benefit but gold is one of them.  Stocks participate in a company´s growth and earnings, bonds and cash generate interest, commodities such as copper have industrial utility and food commodities keep the world fed.   Gold is very much the exception.  In 2020 only 8% of the gold produced went into industrial applications. 92% of gold production was for Investment or Jewellery manufacture – sectors where value is based upon sentiment, not utility.
Table of gold production in 2020

Gold as a Currency

Despite gold´s lack of utility it has always been viewed as a precious metal in all senses of the word and has been used as or formed the basis of currencies for over 2500 years.  Prior to the development of paper currencies during the 19th-century gold and silver were the base currencies in most countries.
The value of the US dollar was fixed in relationship to gold up to 1971 and until then the dollar was a fully convertible currency – the dollar could be exchanged for gold at the Federal Reserve.  Back in the 1920s, one US dollar would have been worth (in fact physically exchangeable for 0.045 ounces of gold, but by 2020 one dollar would have purchased just 0.0005 ounces – a devaluation of the dollar against gold of over 9000%!
It is quite possible to see that gold´s role as a financial asset could be usurped.  Whilst it is a finite resource the true reserves are uncertain so production is increased and decreased in accordance with its value, but the total amount of gold above ground is always increasing. The supposed advantage of a digital currency such as Bitcoin is that there is a theoretical maximum of 21 million coins so its value should not be affected by over-production so its value should (eventually) only be determined by demand.  Only time will tell if these electronic currencies move from being speculative bets to become stores of wealth.

The Investment Case for Gold

Perhaps not unsurprisingly the organization entrusted with promoting gold, The World Gold Council, presents a strong investment case for gold.  It identifies some unique characteristics of gold as an asset class that makes it a valuable portfolio diversifier:-

Negative correlation with the stock market during market crashes – as a traditional flight to safety asset gold increases in price when the stock market is in crisis

Positive correlation with a rising stock market – this would seem to contrary to its negative correlation above but the argument is that during good times gold demand for jewelry and industry increases. They state average annual returns over the last 50 years have averaged 11%, comparable to equities.

High Liquidity – gold trading volumes exceed those of Treasury Bills and UK gilts and at an average of £131bn per day during 2020 are similar to volumes of the S&P500.

Inflation Protection – the purchasing power of gold has outperformed all major currencies

Analysis is Handicapped by Limited Historical Data

It seems strange that we have limited data available to analyze the investment case for gold but the reality is we have only 50 years of data available as it was only in 1971 that it was freely floated against the dollar – or depending upon your viewpoint the dollar was freely floated against gold!  We have 100+ years of bond and stock data available so any analysis of gold as an investment class will have far less certainty than that for equities and bonds.
Graph of gold price from 1792 to 2020
Post 1971 the dollar surged in value and increased by over 1400% during the 1970s.  But as the graph below shows, gold investors from 1980 to 2000 would have been disappointed and it was only post-2000 that gold shows some spectacular but bumpy progress.
Graph of Gold Price fro 1970 to 2020

Does Gold Justify The Claim of Negative Correlation with the Stock Market?

We have had three significant market crashes during the last 50 years and in each case, gold showed a strong negative correlation to the stock market:-
Table showing the performance of gold during UK stock market crashes

How Does Long-Term Growth of Gold Compare with Stocks?

There is normally a price for everything.  If gold can protect a portfolio against market crashes what is the cost?  We would normally expect to see the cost of holding gold through a lower long-term growth rate compared to stocks.
Proponents of gold as part of an investment portfolio would like as to believe that there is negligible loss of growth through holding gold.  The Gold Council publish the chart below of the 20-year performance of gold against other asset classes:-
Gold is shown outperforming US equities by 2%+ a year. If this were to be sustained over longer time horizons why not hold 100% gold?  So I´ve analysed gold´s 50 year performance to try and obtain a more balanced view.

The table blow looks at the performance of gold over each decade form 1970 compared with the S&P500 (total return). The negative correlation between stocks and gold is clear to see but it´s not possible to draw any conclusions about relative growth rates:-

Comparing relative performance over longer periods is also problematic.  During the 1970s after the dollar was no longer tied to gold, the price of gold soared by more than 1400%.  This was followed by over 20 years of near-stagnation followed by strong but volatile growth up to 2020.  It really is difficult to draw any conclusions or predict future growth patterns and it would certainly be unwise to think that the around 3% underperformance of gold compared to equities over 50 years is an accurate predictor of future performance.

Bonds or Gold for Portfolio Protection?

The only conclusion that can be drawn from the data is that gold is powerfully negatively correlated with stocks when markets crash.  If the most predictable role for gold is portfolio protection during market crashes the big question is which is more effective – gold or government bonds?
In the case of the UK market, the answer must be gold.  Its performance was far superior to gilts during the 1973/4 and 2007/8 crashes and equal to gilts during the tech crash of 2000.
table showing asset performance during market crashes

Can Gold Be a Worthwhile Addition to a Portfolio?

There is no strong case for holding gold during the early years of the accumulation phase of retirement investment as all data indicates that gold is likely to underperform the stock market and although gold can provide powerful protection against market downturns it is unlikely that portfolio volatility would be a major preoccupation.  The only exception to this is if there is a strong need for short to medium-term capital preservation – perhaps if there is the intention to purchase a pension annuity.
The situation is very different during the withdrawal phase as it is the combination of growth and volatility of a portfolio rather than growth alone that determines the Safe Withdrawal Rate (SWR).  Taking money out of a portfolio that is suffering through a prolonged market fall can hit its value to such an extent that even a powerful market recovery may not be sufficient to ensure that it out-survives the retiree.

The dilemma that investors are faced with is clearly illustrated in the graph below that shows the variation of Maximum Drawdown (the maximum fall in the value of a portfolio) and Safe Withdrawal Rate (SWR) with changes in the equity content of a portfolio:-

Graph of maximum safe withdrawal and drawdown versus equity content of portfolio

(UK portfolio of the total stock market and 15-year gilts 1970 to 1990, 30 year retirement periods)

The maximum Safe Withdrawal Rate (SWR) is obtained with 65% to 75% in equities but this also coincides with the maximum drawdown (decline) of up to 60%.

Many retirees would be very unwilling to accept such a drastic fall in the value of their retirement savings.  Increasing the bond holding in the portfolio isn´t an effective solution either, as with only 40% in equities the SWR falls to 2.8% – a 20% reduction in a retiree´s income yet the portfolio will still be subject to a potential 50% decline in value during a market crash.  Reducing volatility and drawdown by weighting the portfolio towards bonds has a high price and is not that effective.  This is where gold comes into play.

Gold in a Portfolio

The ability of gold to reduce the volatility of a portfolio acting rather like a car´s shock absorbers is of great value to an investor in drawdown
The graph below based upon FTSE All share and 15+ year gilts (1970-2020) and shows for various ratios of stocks and gilts how gold can reduce the maximum decline (drawdown) of a portfolio:-
A typical 60/40 equity/bond portfolio has a maximum drawdown of 57%.  Adding 20% gold in place of gilts reduces this to 37%. As a rule of thumb, for every 5% of gold, the maximum Drawdown is reduced by around 5%.
The effect of gold on the Safe Withdrawal Rate (SWR) is more dramatic:-
Graph showing the improvement in safe withdrawal rate by adding gold to a portfolio
A 60/40 portfolio with no gold has a historical SWR of 3.4% (after charges of 0.3%).  Adding just 5% gold in place of gilts improves this to 4.4%.  20% gold increases the SWR to 5.6%.  Every 5% of gold improves the SWR by 0.25%.
The other significant benefit of adding gold to the portfolio is that it flattens the equity-SWR curve so that reducing the equity content of the portfolio has a more gradual negative effect on SWR.  With no gold, the SWR halves in value in an all bond portfolio compared to a 100% equity portfolio, whereas with 5% gold there is only an 18% change in SWR.   A risk-averse retiree who is unhappy with the idea of an equity-heavy portfolio can add 5% gold and reduce the equity weighting without taking too great a hit on his income.


Based on the last three market crashes gold can significantly protect a portfolio from severe market downturns and is more effective in this than holding government bonds.  Perhaps more significant for retirees in drawdown is that as little as 5% of gold in a drawdown portfolio will increase the maximum amount that can be safely drawdown as retirement income and allow the equity content of a portfolio to be reduced without greatly reducing its income potential.

The evidence that gold can provide growth just a few percentage points behind that of equities is far less certain as the 50-year performance of gold is distorted by its stunning growth in the 1970s after the ending of convertibility and the dollar-gold pegging.  Uncertainty over the likely future growth rate of gold and the distortions of its performance in the  1970s must lead to treating gold heavy portfolios such as Harry Browne´s Permanent Portfolio and the Golden Butterfly with a degree of caution.
 The evidence is that gold should belong in a drawdown portfolio but perhaps not to the extent that analysis of the last 50 years indicates. My own drawdown portfolios are now targetting around 13% in gold, down from 20%, which I think is a reasonable compromise between a healthy SWR  and the risk of lower growth.


  • seajay says:

    The US started the end of pegging the US$ to gold in the late 1960's, officially making the break in 1971, as a means to help pay down the cost of the Vietnam war. When pegged at a fixed/constant exchange rate (pre 1970's) it made more sense to hold money deposited and earning interest that could then be exchanged into gold as/when desired. If the money was deposited into Treasury bonds/bills then that was like the state paying you for it to securely store your gold. As such the correct measure of the value/gains in gold might be considered as T-Bill interest rates pre 1970's and gold prices since then.

    Another factor to consider is that in the likes of India where state currency is less trusted due to devaluations/defaults, a common preference is to hold gold and convert that to currency as/when required. There's a liquid/easy market to use gold as collateral in exchange for money/cash, a bit like a pay day loan, and then later pay back the money + some interest, typically around 0.75%/month in order to have their gold returned. For the other party who might like to hold gold as part of their portfolio, such gold collateral can be considered as being on their books during the period of the loan, and where that gold is earning interest (0.75%/month). Typically they only lend cash amount to 70% of of the spot price of gold, so if the loan is defaulted they keep the gold and in effect 'bought' such at a 30% discount.

    Buffett's oft repeated statement about gold is akin to saying that buying a farm and leaving it idle is wasteful. Work the farm and it can produce dividends. Trade (volatile) gold since the 1970's and it can produce dividends. A reasonable method to trade gold is to barbell it with stocks, two polar opposites that combine in a similar manner to how a 1 year and 20 year Gilt barbell combines to be like a central 10 year bond bullet. US data, but similar for the UK https://tinyurl.com/3y4ej4u9

  • Max says:

    Really insightful comments Seajay. So would you hold gold and if so how much?

Leave a Reply