Why Gold is Not the Ideal Tool for Capital Preservation

​Capital preservation assets provide the lowest volatility possible while sacrificing upside potential when times are good. We find that while gold can be additive to portfolio returns, its cost of high volatility does not make it the best asset class for capital preservation. Instead, we prefer income generating asset classes with more stable return and volatility profiles such as Treasuries and G6 sovereign bonds.

Asset class returns are unpredictable, but the relative levels of volatility tend to be more consistent through time.

​​The most recent point of maximum selling pressure was considerable. While it is impossible to predict the future, ignoring the lessons of history means one is condemned to repeat it. Hence the importance of historical returns as they indicate which parts of the global financial market have acted as safe havens. 
 
Our periodic table of nominal investment returns and volatility as shown above includes asset classes ranging from the riskiest to the most defensive. The table has two components, or grids: The upper grid represents the implicit cost, or variability, of asset class returns in each calendar year. The bottom grid simply shows the 'reward' offered by each asset class, expressed in terms of total returns. 

Just as growth comes with a cost, so does protection. 

​The upside potential that stocks offer comes hand in hand with greater variability of expected returns. Similarly, capital preservation and the benefit of lower volatility comes from income-generating assets at the expense of limited upside. With this observation in mind it is worth noting that: 

• The best performance from US Treasuries was 14% in 2008 and a close 13.5% in 2000, both recession years. Their worst performance was -3.6% in 2009.
• In the lower grid, global equity volatility consistently ranks among the highest in the group.
• Income-generating asset classes (including emerging market debt) occupy the lower half of that grid, thus accounting for the lowest rungs of volatility of asset class returns.

• In 2002 and again in 2008 (both recession years), sovereign government bonds had a double-digit gain, and gold ended up as well. 
• However, gold has levels of volatility that are comparable to global equities. 

 
Therefore, while asset class returns are unpredictable, the relative levels of volatility tend to be more consistent through time. The upper grid shows more consistency in the degree of the variability, or volatility, of the returns of asset classes. We find that, unlike gold and equities, income-generating assets consistently demonstrate the lowest rungs of volatility available in global financial markets. 
 
Gold can have high volatility coupled with years of double-digit losses.

Therefore, gold does not act as a capital preservation buffer given that it has failed to counteract the general level of volatility observed in global equities. It is undeniable, however, that its returns can be additive to a portfolio. 
 
And unlike sovereign bonds, gold does not generate any kind of income stream—an added bonus for investors seeking capital preservation. In the next post, we’ll explore the issue of capital preservation in a world of balance sheet expansion and negative yields.