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4 Reasons Why Gold is a Popular Alternative Asset

William Freedman

Topics: Retirement, Investment Advisors, Third Party Administrators, Alternative Investments

Takeaways 

There are at least four compelling reasons one might include gold in a retirement portfolio: 

  • Hedging against inflation 
  • Tangibility 
  • Portfolio diversification 
  • Liquidity 

 

Hedge against inflation 

When it comes to inflation, we're spoiled here in the U.S. It's been 40 years since we last worried about runaway inflation, and you'd have to go back to Revolutionary times to find a period when America experienced the kind of hyperinflation that more recently swamped economies in Venezuela, Zimbabwe, and elsewhere. Hyperinflation occurs when consumer prices rise 50% or more in a month. Going back to at least the 1950s, we’ve never seen inflation exceed 14% in a year. 

  

And a little inflation is healthy. It means investors expect high returns, and workers expect raises. We're currently experiencing a wave of inflation approaching 5% year-over-year, though it's unclear if this is a factor of supply-chain snafus or if this is the new normal. Either way: Poor, poor, pitiful us. 

  

Even so, the U.S. dollar, like any currency that experiences even slight inflation, depreciates over time. Considering the greenback is the world's leading reserve currency, the question is: Depreciates against what? The answer is gold. 

  

Tangibility 

Cryptocurrency could also serve as a hedge against inflation, but there are two caveats when you compare bitcoin and its ilk against gold and other precious metals. The first is that, as we reported here, humankind has valued gold for 40,000 years; crypto, meantime, is only about a dozen years old -- and one of those years was 2018. The other is that crypto is really just a string of digital signatures -- but gold is real. You can make jewelry with it. You can use it as dental fillings. You can let your inner 007 villain loose and think of new, creative ways to display it.  

  

Portfolio diversification 

Economists tell us that gold diversifies a portfolio diversifier because of its negative correlation with other asset classes. 

  

“Our results show that stock portfolios including gold stochastically dominate those without gold at the second and third orders,” according to a 2015 paper published in the International Review of Financial Analysis. “This implies that risk-averse investors would be better off by including gold in their stock portfolios to maximize their expected utilities.” 

  

Liquidity 

The thing about gold is that, at any given time, somebody wants to buy it. 

  

Maybe they won’t bite at the price you want to sell it at. Like any asset, it goes up and down in value, although its cycle is slow and its long-term trend is ever upward. But let’s say you find yourself holding gold at a price below what you paid for it. Let’s also say you need cash in a hurry and can’t wait for the market to rebound. You can always borrow against this hard asset. 

  

The same can be said for real estate, but let’s focus on the one thing that’s said for real estate that cannot be said for gold. “Location, location, location.” While how much a place is worth depends on its proximity to places other people want to be, one bar of gold is exactly like every other bar of gold. This fungibility makes it a lot easier to sell. 

  

Untapped mine 

 It’s hard to find out how much of America’s retirement nest egg is invested in gold but, if we were to estimate, we’d say “Not a whole lot.” 

 

First, this is one of those assets for which self-directed individual retirement accounts are the only permissible ERISA-approved vehicle, and these comprise at most 5% of total IRA assets. And we know that real estate accounts for at least a plurality of that value, so precious metals are left to slug it out with crypto, private placements, and the rest of the allowable assets. 

 

Still, it’s gotten to the point where there’s an Investopedia glossary entry for “Gold IRA” and any TPA who can compete on customer support, service to small investors, service to first-time buyers, help with rollovers and price transparency could be getting in on -- quite literally -- a gold mine. 

There are rules, though. First, an account holder who already has a self-directed IRA probably can’t keep gold in it. Precious metals need to be administered separately in their own designated account. But that rule is interpreted broadly. 
 

"Gold IRAs can also contain gold stocks (shares of gold mining/production companies), gold mutual funds that invest in bullion or stocks (or both), and gold ETFs that track gold indexes," Jean Folger writes for Business Insider. Still, there are other requirements. "You also need to select a precious metals dealer that will make the actual gold purchases for your IRA. … You can't just buy any bar or ingot, either. Physical metals must meet IRS 'fineness' standards as their purity and weight and be stored in an insured IRS-approved depository. When it comes to coins, you are limited to bullion coins issued by certain government mints." 

 

And, of course, if the account holder is buying physical gold, somebody has to store it. When precious metals are transferred, the new owner doesn't typically pull a U-Haul up to the former owner's house. More often than not, the bullion remains in whatever storage facility it was in already; it's just that the paperwork on it gets sent to a new address. At most, it gets forklifted from one pile to another pile. But it remains the TPA's responsibility to manage this, even if it means taking possession of the physical asset. 

 

"Storage is a consideration for those who hold gold IRAs. You have to keep your physical gold at an IRS-approved facility, such as a bank or other depository," according to Investopedia. "You can also hold it with an approved third-party. This means [account holders] can't store [their] assets at home. If [they] do, it counts as a withdrawal, and [they'll] have to pay taxes." 

 

At the close 

If you are a TPA and you’re already set up to administer self-directed IRAs, then you’re past the first hurdle for supporting gold as a value add.  

  

But there are many ways to own gold: physical assets, commodities futures, ownership of gold mining company securities, participation in precious metal mutual funds. And if you set out your shingle as a gold IRA specialist, you'll need to know the ins and outs of all of them. 

  

And of course, there are the usual regulatory limits on holding and purchases, as well as a fairly unique set of risks and advantages. 

  

Ultimately, though, this niche is already making a difference for a few pioneering administrators and the financial advisors savvy enough to partner with them. 

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