In Ep. 305 of the Mullooly Asset Podcast, Tom, Brendan and Tim discuss the merits of gold as a diversifier in your portfolio. Does it actually work? Is it good at keeping up with inflation compared to stocks and bonds? Is it worth the risk?
They also discuss the situation many colleges and universities are facing and if it’s worth it or not for students to enroll and pay full sticker price if campuses aren’t open in the fall.
Is Gold a Good Diversifier? – Transcript
DISCLAIMER: Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management.
This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions and securities discussed in this podcast.
Tom Mullooly: Welcome back to the podcast. This is episode number 305, cruising from West Virginia 304 into Miami, Florida 305. Along for the ride with me is Brendan and Tim Mullooly. Welcome to the podcast.
Tim: Welcome back. Tom. Last week I had to look up the area code cause you weren’t here so glad to have you back.
Tom Mullooly: So we’ve got a couple of things that we want to talk about in this week’s podcast. I wanted to start off by talking about MacMurray college closing after 174 years. This is unfortunately going to be the way some schools are going to go.
Tim: Yeah. There was an article in the wall street journal that was talking about how the Coronavirus has put some serious strain on a lot of schools out there. Obviously everyone knows colleges aren’t in session in terms of having people on campus. They’re doing a lot of virtual learning and they’re not sure at this point if students will be back on campus at the beginning of next semester as well.
For people listening out there, it just enhances the conversation that was already happening about college and the cost surrounding college. It’s been getting more and more expensive every year and now if you’re unsure of if you’re going to be on campus physically learning or not, I think it’s really important to determine if the cost is worth what you’re going to be getting.
Brendan: I don’t know if I’d be super interested in paying full price for a semester of potentially all online learning, but on the other hand, I’m not sure that this is going to be the nail in the coffin. Meaning people have been predicting that the cost of college can’t continue. People aren’t getting out of college, what they pay to attend it. I’m not sure that this erases college from the map of American society. I think those takes are a little extreme. I’m not sure if I’d be signing up for a semester of online learning in the fall.
Tom Mullooly: I look at that and say, “Hey, wait a minute. If I can stay home and work on getting my degree from C.W. Post or Princeton, it doesn’t matter if I’m in New Jersey or out on Long Island. If I have the chance to graduate from a prestigious school with a good degree and it doesn’t cost me that much,” we may be attacking a problem that we’ve been talking about on a lot of videos and podcasts around here and that’s student debt.
I’m saying that there may be a path to lower costs-
Tim: Yeah, I think-
Tom Mullooly: if you’re not on campus.
Tim: Yeah. It would be less expensive to go to a school like that. But I mean you’d still have to get into Princeton.
Tom Mullooly: Of course.
Tim: So if that option is available for you, then it’s definitely more enticing to pay less and you’d still graduate with the same degree from the same school.
Tom Mullooly: And I would imagine that the online courses would be just as challenging as sitting in your kitchen taking these courses versus being in a classroom or sitting in a large lecture hall.
Brendan: I think the biggest problem is probably for people who are just about to go away to school because it doesn’t necessarily matter as much where you begin your college career, it matters where the degree is from.
I think that’s just reality. Some people would argue that it doesn’t matter at all. So I think if you’re going to be entering college for the first time in the fall semester, you got to be thinking about, “Can I do this cheaper or more efficiently,” at least for a semester or two and maybe knock out some basic level requirements and then apply to the school that I wanted to go to when I can actually go there in person.
Tom Mullooly: Right.
Brendan: Because I do feel that a good part of the experience of college is the experience. It’s being there and meeting people and living on your own for the first time in your life probably. So I think there’s something to be said for that. And like I said, I don’t know if I’d be willing to pay full sticker price for my first semester away at a school if it’s not going to be away, if it’s just going to be online.
But if they’re going to offer a discount, then maybe.
Tim: Especially building off of that, I wouldn’t want to… I’d be less likely to want to take student loans out to do an online course like that. Maybe find something cheaper where I don’t have to take out loans for the time being to take classes online and then reassess the situation once colleges start having people back in person again.
Tom Mullooly: There is a serious risk though to the entire structure of how universities work. In the article, they talked about how Johns Hopkins was on track to post a profit and now they’re forecasting a $100 million loss. Part of that is because they run a hospital alongside their educational programs there. There’s a lot of things that get factored into this. They also cited Clemson in the article. They have $128 million budget that they have for athletics. 31 million of that money comes in from ticket sales. Most of that from football, that may go away.
Tim: It was kind of shocking, I think to see how many schools… considering how much money they bring in either from athletics or just from enrollment. I mean every student at most schools now-a-days probably paying $20,000, $30,000 or way more. It was interesting to hear how many schools operate on a razor thin margin or potentially operate at a deficit. Even just one semesters worth of enrollment loss is enough to put a lot of these schools out of businesses.
Brendan: At the same time. It’s not really that surprising though because these schools are a business at the end of the day. I mean most businesses, if they had to miss a semester… Let’s call it a half a year roughly, of earnings for a college usually is the case. So if a business had to miss half a year of their earnings from whatever field they’re in, I think they’d be in pretty big trouble too, which is exactly what we’re talking about with the economy at large. So it’s just-
Tom Mullooly: The other side of that… The argument though with the schools is that a lot of their business is in fundraising, is in raising money for the endowment. Whether that’s for their annual fund, for operating or for future scholarships. Even that’s going to be affected now because people are out of work.
Brendan: One thing I was going to add though is if push came to shove and numbers are really down, then one thing that gets excluded from this conversation is maybe they’re operating on not so high margins. When you don’t factor in the fact that a lot of these schools have giant endowments… And I know that they’re earmarked for stuff, but if it’s between the school shutting down or them raiding the endowment, I think they’re probably going to raid the endowment.
Tom Mullooly: They have to get permission.
Brendan: What else are they going to do?
Tom Mullooly: They have to get permission from the donors to do something like that.
Brendan: I understand but you can’t invade it but, like if the school cease to exist then why do they have an endowment? What’s the point? There isn’t one, it’s there to support the school and functions of the school. So I think if it really came down to it, which I don’t think that we’re going to get to that point. But if it really did then these schools have more money than their current cashflow situation would dictate. Even if enrollment is down, the money’s there,
Tom Mullooly: Yeah, but the problem is that it’s sitting in restricted funds and the use of the funds is restricted. They can’t just dip into it without getting permission from the donors, the grantors to do something like that. But-
Brendan: Yeah I understand-
Tom Mullooly: It may come to that.
Brendan: If they go to the donors and say, “The school’s going to close or we’re going to use the money for something different than what we said it was.” I think they’re probably going to be able to use the money because if the school doesn’t exist. Then what is the endowment fund?
Tim: So kind of switching gears, there was an article in Morningstar from John Rekenthaler that I wanted to talk about. It was about long bonds and gold as portfolio diversifiers. John wanted to take a look at… Instead of using just an aggregate intermediate term bond as a diversifier away from regular stocks and the equity side of your investment allocation, he used long-term bonds to see how the performance would hold up.
Through his study he saw that the long-term bonds that he used in the portfolio actually increased the performance significantly over the aggregate bond, but I just wanted to get your guys’ thoughts on that. In terms of practicality for individual investors on a day to day basis.
Tom Mullooly: Well, we should clarify that he was talking specifically about long-term treasuries and not a mix of corporates in there and it was specifically the long-term treasury. One of the things I wished that he had taken a look at before he had written it would have been, what would happen if you had paired a portfolio of equities with a zero coupon bond?
Brendan: It’d be even more extreme.
Tom Mullooly: Right. 25 or 30 years in maturity, in those cases it does… A Zero coupon without the cashflow, without the coupons that you get twice a year, they become a lot more volatile with changes in interest rates.
Brendan: I thought that the biggest thing for me was I think long-term bonds, they offer you the most downside risk when paired to stocks, long-term treasuries are going to offset the stock market losses the most, at least historically speaking.
And I don’t see any reason to question that moving forward. If you do then I’m not sure what the alternative is at the at this point for you because nothing else is as negatively correlated to the stock market as that.
But the long-term bonds are also super volatile. So if you look at the standard deviation of a long-term bond, it’s way more than an aggregate index in the sense that, when the stock market rips in a year like 2019 or 2013 are coming to mind. You have years like that and your bonds aren’t going to be flat in a year like that. You’re probably going to lose money in the long-term bonds and the article position them as… Part of the return historically that you got that you improved your portfolio returns from was yields, you collect more of a yield on a long-term bond than you do on a short term bond.
So over time you’re going to be rewarded for holding them. But also you get an insurance premium. So it’s smoothing out the ride when your stocks are down, you’re getting that.
But I think there’s a big behavioral risk to it because people don’t view their portfolios as a whole entity even though they probably should. They look at the individual parts and say like, “Hey, these bonds suck. They’re holding us back and the market’s doing well most of the time.”-
Tom Mullooly: We had these conversations with people at the end of last year not all that long ago. Why are we holding these bonds? You’re absolutely right.
Brendan: So long-term bonds from this period of time, 1986 through last week were the best offset to the stock side of your portfolio, but you also have to worry about all of the weeks and months in between there where people are checking out their portfolios and saying like, “Hey, these long-term bonds, they’re volatile,” and volatile in the wrong direction a lot of times because the market goes up most of the time.
Tim: That was the one thing that I was going to say about the article in general is that you can’t dispute the performance numbers that he gave, but at the same time that is under the assumption that these people held on to the allocation and held onto these specific bonds the entire time from 1986, I think when he started, through this year. And if we know individual investors, I mean the likelihood of that is not-
Brendan: And their advisors.
Tim: And their advisors, yeah.
Tom Mullooly: They check their portfolio every nine minutes now.
Brendan: I think advisors are just as much to fault for this as anybody else though because I saw something recently that showed that on average advisor portfolios hold more short duration fixed income because, I would imagine specifically, advisors are not interested in having a conversation with their client about why the long-term bonds are more…
They’re more of a drag during the good times and they’re more of a help during the bad times. So I think on that topic, advisers would prefer not to have that conversation. So instead of holding long-term bonds, they hold short and intermediate term ones because they don’t have to discuss them as much because they don’t get whacked as bad when the market’s having a good time.
Tom Mullooly: I had to chuckle when I read through the article, and he went back to the eighties because I actually worked through this period. So I just want to lay out a scenario for you. In January of 1986, the Dow Jones hit 2000 for the first time. Okay.
And it added a hundred points it seemed every week or two. Initially, January… The first quarter was fantastic. By late July it hit 2,700. So imagine the first six or seven months the market basically in 1987 had gone straight up. In April of the same year, a long-term treasury bond yield was 7%, by October of that year, the yield was 9.9%, people had their own stock market crash in long-term bonds. They lost 25% of their investment and people were flipping out. I know I saw it. People were like, “I thought these things were safe. What is going on with this market? ”
Yields moved from seven to nine plus percent. The Friday before the stock market crash in 1987 the yield actually hit 9.99, it was almost 10% that day, and that’s when people say, Hey, you know what? I don’t need to be in the stock market if I’m going to get 10% on a government investment.”
But the problem is that while you had a… Basically the equivalent of a stock market crash through the summer of 1987, okay. From that point forward, for the next 30 years, the rates on long-term treasuries went from nine plus percent to two. It’s really good to see this in terms of “Hey, long bonds really were a good pick to have with your investment.” I just don’t know if that’s the right answer for the next five years, 10 years, 20 years. I don’t know. The rates are so low.
Brendan: Rates have been low though since the financial crisis and people have probably been avoiding long-term bonds since 2009, 2010 because-
Tom Mullooly: Absolutely right.
Brendan: For the same reasons. That’s a decade now. A decade of being wrong.
Tom Mullooly: Yeah.
Brendan: And unbelievably so. I agree that in 2009, 2010 I probably would have agreed that “Hey, yields are so low in these things, there’s no way you get that kind of price appreciation moving forward.”
But guess what you did-
Tom Mullooly: Yeah.
Brendan: I don’t know if I was… I wouldn’t back up the truck and have long bonds as my only exposure. But I also wouldn’t eliminate them offhand just because yields are low today because we don’t know.
Tim: I think it also goes back. We have conversations with clients all the time… Or between ourselves too, what’s the purpose of bonds in your portfolio?
If you’re looking for the price appreciation on the bond side, those are supposed to be your stabilizers so to speak. That’s in our opinion, what you should be using bonds for in your portfolio. So you’re not looking for out-performance in your bond fund. That doesn’t necessarily matter. You want it to just cushion the blow when stocks take a hit and that’s not going to be the case as much with long bonds as it would be with inner intermediate or short term bonds. And the article also then went on to move from long bonds to gold, and I feel like the same thing is true for what we just said about long bonds. The same thing is true with gold only just amplified to an even more violent stage because gold just swings up and down on an even more violent path than long-term bonds would.
Tom Mullooly: I’m smiling cause I know that Brendan is about to give his investment thesis behind gold.
Brendan: I just think that if you’re going to look at long-term bonds like insurance, which I think John wrote in the article and I think makes a lot of sense. So you’re going to have a cost… In years where the market is up you’re going to have a cost your insurance premium because you had these bonds in your portfolio and you didn’t need it because you didn’t have a car wreck. But if you’re going to infuse gold into that to be a diversifier, you talk about things like golds… Gold and just all alternatives in general, you hear this for things like managed futures and a lot of alternative investment strategies, they’re uncorrelated. That doesn’t mean that there negatively correlated.
So meaning, instead of having an insurance policy, so treasury bonds… And this doesn’t always work perfectly for them either.
Sometimes they go down in tandem with the market, but they’re probably the best thing out there we’ve got in terms of offsetting market losses. So with that you have just a pure insurance policy, meaning you crash your car, the stock market’s down, your bonds are going to offset you to some degree based on how much insurance you bought, how much your money had in bonds.
Tom Mullooly: It’s the airbag.
Brendan: Right. But if you do that with gold, gold is just random. So you could drive around and have… It’s a nice sunshiny day and you just go for a drive and they’re like, “Here, here’s the payout.”
And you’re like, “What’s this for? I didn’t crash my car.”
And Gold’s like, “Hey, just take this money, it’s fine.” And then you crash your car. And gold is nowhere to be found. Nothing to offset your losses whatsoever because gold is random.
There is no… It’s not there for you When the market goes down, it might be down more than the market. But, considered in the context of an overall portfolio like a lot of alternative strategies are, you can look at it and say, “Hey, you got a similar return and the volatility wasn’t as bad and so you should have five or 10 or whatever percent in this thing.”
Again, I just think the behavioral risk, you’re like, “Hey, you know bonds and stocks did this. What the heck is gold doing? Why is it doing that?” And if it’s not there to help you when you need it in terms of offsetting risk, I’m not sure most people can hang with an asset class like that in their portfolio.
So if your thesis is just like, “Gold went up the last couple of months, let’s put money into it.”
Tim: We talk about how hard it is to time the market with stocks, trying to time gold, good luck.
Brendan: If you like GLD today at the price that it’s at, you could have bought it at this price in 2011-
Tim: Almost 10 years ago.
Brendan: And you would have been underwater the entire time from then until now.
Brendan: So I don’t know about moving forward into the future, I just know that in the past gold has been totally random and to bake that in as a big component of your portfolio, I don’t know what you should expect from that. It might help move them forward.
It might not. It might be a diversifier, It might not. I don’t know.
Tom Mullooly: We don’t know. I mean, one of the arguments that I heard recently was, “Hey, the fed printed…” I’m using air quotes, “Printed money coming out of 2008,” with all this quantitative easing and now they’re doing even more printing.
We got to have inflation with that. So don’t you think that gold will do well? I don’t necessarily believe that.
Brendan: We had an episode of the podcast within the last year where we talked about gold as an inflation hedge, and I have numbers because I remember talking about this. So since 1975 when it became legal to own gold again on a real basis, meaning adjusted for inflation, gold has returned 0.8% a year annualized. Stocks have returned 8.3% a year annualized on a real basis over that time period. Meaning that should be the primary inflation hedge in your portfolio just stocks. And bonds… So again, maybe not the best predictor of future returns, but over this time period from 75 through-
Tom Mullooly: That’s 45 years.
Brendan: last year, you got 5% a year real return on your bonds. Now again, with yields where they are today, I’m not sure you’re going to get a real return on your bonds, but I think you probably still want to own them as an insurance for your portfolio anyway if you’re at such a stage where you can’t afford the volatility because you’re living off your money or close to it.
But even if there’s no real return, if gold is supposed to be the inflation hedge, I’m not sure I see historical precedent for that. You could look during pockets of that time where it was, but then you could see other times where it wasn’t.
So I’m not sure you could bank on that in the future if there even is inflation. Because we heard the same boogeyman stories about inflation coming out of the financial crisis-
Tim: Right and did that happened?
Tom Mullooly: No.
Brendan: The inflation never came.
Tom Mullooly: Yeah. I thought the way that it was phrased in the article made a lot of sense. Good news about gold, the returns were uncorrelated with the equities. They’re going to do their own thing. And he said the bad news about gold is the correlation was not negative.
Brendan: Right there you go, which is-
Tom Mullooly: So it means that, if your stock portfolio has a car crash and you own gold, you could actually have a car crash and crash into your house. It could be even worse.
Brendan: The gold could be down too.
Tom Mullooly: Yeah.
Brendan: And again like we said, no guarantees for bonds being the perfect seesaw relationship with stocks either. But if we’re using history as any kind of a guide, and if we’re not doing that, I don’t know what we’re supposed to do, then I think treasuries remain the best ballast to the portfolio in terms of set offsetting stock risk.
Tom Mullooly: I still want to go back to Tim’s point about the idea of why you own bonds in your account, that it’s really to be the ballast and it’s not for capital appreciation. Bonds just aren’t. If you get any appreciation, that’s a bonus out of these things. But I would still lean towards an aggregated portfolio today if we were sitting down with a client of different maturities versus just saying, “Yeah, we’re going to put everything in a 30 year treasury.”
Tim: Yeah. I think if that’s the goal and that’s how we approach it here, then yeah, I agree with you. Other people might have different intentions for their bond allocation, but here that’s our philosophy.
Brendan: You’re not doing it at the level that the name implies, but you can kind of duration match it even though you don’t have something with an actual maturity date when you’re owning a bond fund. But if you money in your portfolio, if you’re living on it and you need your money in the next year, or two or, three, you should duration match that and say you’re going to be in short term treasuries because you don’t want to take the… There’s principal risk based on what goes on in interest rates if you own the long bonds. But the intermediate and long bonds could be the mix with stocks that’s supposed to fund stuff starting at some point in the horizon four or five years and beyond. And those things can be a piece in your portfolio that is useful even though not as secure as the short term treasury stuff.
Tom Mullooly: All right, before we move on to our next topic, please give us the Warren Buffett definition of gold as an investment.
Brendan: Oh, is he the one who calls it a pet rock or was that Jason Zweig? I can’t remember.
Tom Mullooly: I thought it was Buffett.
Brendan: Yeah, I think they go hand in hand. Zweig edited the intelligent investor of Graham. So a lot of their stuff gets intertwined in my head, but there’s no return stream. We can project from a business or from a bond from the government or a company. There’s nothing to project with gold. It’s just a rock that you find in the ground and you have to sell it to somebody later for more than you paid for it today. And to predict what people’s feelings are going to be about gold in the future, I don’t really know.
Tim: I think it’s important to talk about it though as advisors because when things get kind of wacky in the market, you always hear about gold spiking or we’ll get questions from clients asking about buying. Yeah. Should we be buying gold? And-
Tom Mullooly: It’s a fear gauge like the VIX index.
Tim: And the tough thing is someone who buys gold in the very short term, they could get lucky with it and make some money and then sell it and think that they’re right.
But the way that we manage money here for people is on a long-term basis. And I think everything that you just laid out points to why gold isn’t really a viable option in a long-term portfolio in any substantial amount.
Tom Mullooly: Okay, that’s going to wrap up episode 305. Thanks again for tuning in. We’ll have to look up the area code for 306.
Tim: You don’t know it?
Tom Mullooly: I think it’s Saskatchewan, but don’t pick that one on me. Thanks again.
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