Gold and crypto won’t protect you from inflation

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Though the narratives are often compelling, the evidence of being able to effectively manage investment portfolios in this manner is scant.

In tactical asset allocation, there is a growing aversion to investing in bonds. This is predicted on the view that central banks will increase rates, and this will be bad for bonds.

This approach fundamentally misses the primary purpose of investing in bonds and ignores their most valuable characteristic – negative correlation with equity markets in times of stress.

The tactical asset allocation approach tends to look at the expected return from each asset class and uses that to justify their place in a portfolio (rather than looking at the expected diversification benefits first), and specifically includes asset classes in your portfolio that reduce the risks associated with growth assets.

As forecast returns from equity markets are reduced, the search for “uncorrelated assets” to generate additional sources of returns for investors is increasing in earnest.

Two common asset classes that are being put forward as unrelated to equity markets are gold and crypto assets. Unfortunately, we don’t really have evidence at this stage to support a thesis that crypto offers diversification benefits.

In the February-March 2020 crash, crypto assets fell 40 per cent, which was similar to shares. In addition, the price volatility has been much higher. While crypto assets may prove to be another source of returns for investors, they should be seen as a speculative asset class at this stage of crypto’s evolution.

Gold has a much longer history and has often been touted as an inflation hedge, and sometimes as a safe haven asset. In some environments it has achieved both. However, the record is mixed.

Meaningless exercise

One insight from history is that rising interest rates can hurt gold prices by increasing the opportunity cost of holding it. So in that sense gold wouldn’t be expected to deliver great returns in a rising interest rate environment.

Typically, most investors’ appetite for investing in gold is episodic and the conviction to invest consistently through the cycle isn’t there.

Given other drawbacks (such as the cost to hold, no cashflows and that its future returns are dependent on the market’s perception of its value rather than its fundamental attributes), a long-term SMSF investor would struggle to build a case to include gold as a key part of an investment portfolio.

In times of volatility and uncertainty, don’t lose sight of what you can actually control within your portfolio. Being “dynamic” over your SMSF portfolio with related hyperactive buying and selling is often a meaningless exercise. Patient, long-term investors are more than often rewarded for their discipline.

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