Sunday, July 28, 2013

Chairman of Harvard Economics Department: BUY GOLD

Well, this is a surprise. Best selling Keynesian economics textbook author and chairman of the Harvard economics department, Greg Mankiw, is out with an NYT column advising that investors should hold some gold in their portfolio. It appears that he has been studying up on the yellow metal. In 2008, in his fifth edition of Principles of Macroeconomics (p.339) he had only this somewhat dismissive mention of gold:
One example of commodity money is gold. Gold has intrinsic value because it is used in industry and in the making of jewelry.  Although today we no longer use gold as money, historically gold has been a common form of money because it is relatively easy to carry, measure and verify for impurities. When an economy uses gold as money (or uses paper money that is convertible into gold on demand) it is said to be operating under a gold standard
That was it, the beginning and end of his discussion of gold. But this is what he has to say today about gold:
A friend posed that question to me a few weeks ago, after watching gold’s wild ride over the last few years. The price of gold was less than $500 an ounce in 2005, but soared to more than $1,800 in 2011, before falling back to about $1,300 recently. He wasn’t sure what to make of it all.
My instinct was to say no. Like most economists I know, I am a pretty boring investor. I hold 60 percent stocks, 40 percent bonds, mostly in low-cost index funds. Whenever I see those TV commercials with some actor hawking gold coins, I roll my eyes. Hoarding gold seems akin to stocking up on canned beans and ammo as you wait for the apocalypse in your fallout shelter.
But I was also wary of imposing my gut instinct on my friend, who was looking for a more reasoned judgment. I knew that some investors saw gold as a key part of a portfolio. The author Harry Browne, the onetime Libertarian presidential candidate, recommended a permanent 25 percent allocation to gold. In 2012, the Federal Reserve reported that Richard Fisher, president of the Federal Reserve Bank of Dallas, had more than $1 millionof gold in his personal portfolio.
So, before answering my friend’s question, I dived into the small academic literature on gold as a portfolio investment. Here is what I learned:
THERE ISN’T A LOT OF IT The World Gold Council estimates that all the gold ever mined amounts to 174,100 metric tons. If this supply were divided equally among the world’s population, it would work out to less than one ounce a person.
Warren E. Buffett has a good way to illustrate how little gold there is. He has calculated that if all the gold in the world were made into a cube, its edge would be only 69 feet long. So the cube would fit comfortably within a baseball infield.[...] 
Because gold is a small asset class with meager returns and high volatility, an investor may be tempted to avoid it altogether. But not so fast. One last fact may turn the tables.

IT MARCHES TO A DIFFERENT BEAT An important element of an investment portfolio is diversification, and here is where gold really shines — pun intended — because its price is largely uncorrelated with stocks and bonds. Despite gold’s volatility, adding a little to a standard portfolio can reduce its overall risk.

How far should an investor go? It’s hard to say, because optimal portfolios are so sensitive to expected returns on alternative assets, and expected returns are hard to measure precisely, even with a century or two of data. It is therefore not surprising that financial analysts reach widely varying conclusions.

In the end, I abandoned my initial aversion to holding gold. A small sliver, such as the 2 percent weight in the world market portfolio, now makes sense to me as part of a long-term investment strategy. 


  1. It's pretty simple Greg. You can't print gold.

  2. Just 2%? Maybe for a multi-billioinaire, 2% would be sufficient to live on should his 98% exposure to fiat suddenly take a serious nosedive.

    But what about the average Joe? I think I read on Zero Hedge that the median net worth in the US is a paltry $38,000. That's it. Two percent of $38K is $760. That's about half an ounce of gold. This is supposed to shield people from raging inflation? I don't think so.

    Try 10-20%. And once you have exposure to physical, you should consider a small amount in mining stocks. It's quite volatile and not for the faint of heart, but it could pay off handsomely for those willing to assume the risk.

    Whatever you do, steer clear of bonds. They're a sucker's bet.

  3. "optimal portfolios are so sensitive to expected returns on alternative assets, and expected returns are hard to measure precisely, even with a century or two of data. It is therefore not surprising that financial analysts reach widely varying conclusions."

    Translation: Everything we teach about economics at the "Big H" is unadulterated bullshit. We are clueless...

    HA! Don't ya just love it?