A gold bug is a term used in finance to describe investors who are doubtful of the sustainability of fiat currencies. Their deeply rooted belief in sound money that is backed by something tangible leads them to believe that investing in gold and precious metals is a way to protect their wealth against the devaluing of currencies.
Although the term can be used in a positive way it can also be considered derogatory.
Gold as an investment
Gold has been around for thousands of years, and it has been used as a currency and a way for people to exchange goods and services. However, in recent years it has no longer been used as a medium of exchange.
The arrival of cryptocurrencies, like Bitcoin, has also made investors shy away from gold, and look for other alternatives. There is still a large community of gold bugs. Individuals who advocate for sound money that is backed by gold. The end of the gold standard pushed some investors away from investing in precious metals and gold.
How much gold should I have in my portfolio?
There are certain investors that do not advocate investing in gold. The reason is that gold does not produce anything. In fact, if we compare stocks with gold, they are businesses that generate cash flows and earnings. Gold on the other hand just sits there. A gold bug is hoping to sell his asset for a higher price than what he bought. However, that price is mainly determined by supply and demand. It should also be noted that mining costs also play a role in determining the price of gold.
Warren Buffett has been one of the most outspoken investors against being a gold bug. Here is a video where he explains why investing in gold does not produce anything:
Despite Buffett’s view, there is a place in some portfolios for gold. As it can diversify your holdings, and act as a hedge against different risks that could negatively impact your investments.
Gold as an inflation and recession hedge
As we see inflation continue to rise across the globe, many gold bugs continue to advocate gold as the best asset to protect your portfolio against inflation. Gold has proven to have a negative correlation with the market during a recession. As investors shy away from equities and move into safe-haven assets like bonds and gold.
This does not mean necessarily that in a future recession we could see gold beat the market. However, it could be important to have minor exposure to the shiny gold metal, without becoming a gold bug.
Gold as a hedge against currency devaluation
Most currencies have continued to be devalued over time. However, gold has been able to maintain its value when we account for inflation. This has been one of the strongest gold bug arguments as to why investors should allocate part of their capital to gold.
For instance, in Turkey, it is common for individuals to exchange the Turkish lira for gold. As their currency continues to be devalued, there is a need to convert that capital into alternatives. Despite the efforts of trying to convince Turks to keep their savings in the Turkish lira, many are aware of the risks and are forced to find alternatives if they want to maintain their purchasing power.
The Fed is a gold bug
Although most investors do not directly invest in gold, central banks do. The reason is that although their currency is not backed by any tangible value, having gold reserves is important. As it allows them to have backing for loans, and to reduce currency risk if a country is hit by a recession.
Gold and fear
Since gold is a commodity, and its price is mostly influenced by supply and demand from market participants, it is important to understand what can drive prices higher or lower. World conflicts, fear, as well as inflation, tend to be the main drivers behind higher gold prices. Over the years, there were a number of occasions where gold consistently increased in price due to these reasons. Conversely, the price might also decline in the abstinence of fear, inflation, and military conflicts.
Ultimately if you have considerable exposure to gold, you are essentially betting on rising fear levels. This is the only scenario in which investors would flee from risky assets such as equities to gold.
