In the world of investing, there are individuals who staunchly advocate for the merits of a particular asset class, often to the point of being labeled "perma" investors or enthusiasts. Amongst these groups, gold bugs, for example, are known for their unwavering belief in the long-term value of gold. While investing in precious metals can have its advantages, it is essential to understand the potential risks that come with a single-minded focus on any asset or asset class, such as precious metals or gold. In this article, we delve into the perils of being a perma investor and explore the associated risks that can hinder investment success.
Many investors see commodity investments as a safe haven for money, especially precious metals such as gold and silver. Gold, silver, and other physical assets are perceived as places to store wealth for more stable returns and low risk investments. More specifically, people invest in precious metals such as gold and silver for various reasons, such as:
1) Store of value: Precious metals have been used as a store of value for thousands of years. They are seen as a hedge against inflation and currency devaluation. During times of economic uncertainty, when traditional investments like stocks and bonds may be volatile, precious metals are viewed as being able to provide stability.
2) Diversification: Precious metals offer diversification benefits to an investment portfolio. They have a low correlation with other asset classes like stocks and bonds, which means their value may move independently of traditional investments. Some people advocate that adding precious metals to a diversified portfolio can help reduce overall risk.
3) Tangible assets: Unlike stocks or bonds, precious metals are physical assets that you can hold in your possession. This tangibility provides a sense of security for some investors who prefer to have a portion of their wealth in something they can physically access.
4) Demand and scarcity: Precious metals have inherent value due to their rarity and historical demand. Gold and silver have industrial uses, and they are also used in jewelry, technology, and other sectors. The limited supply and ongoing demand can support their value over the long term (unless an asteroid hits Earth with a huge amount of gold deposits… then this principle becomes moot!).
While these reasons may make gold and silver seem like a compelling long term investment, there are many risks associate with such a strategy:
1) Volatility: While precious metals can provide stability during uncertain times, they can also experience significant price volatility. Their prices can be influenced by factors such as economic conditions, geopolitical events, and market sentiment (or by how JP Morgan decides to control it’s enormous silver reserves!). Short-term fluctuations in the price of gold and silver can impact the value of an investment. Like with any commodity, macro level supply and demand level changes will greatly influence the price
2) No income generation: Unlike dividend-paying stocks or interest-bearing bonds, precious metals do not generate any income by themselves. They rely on price appreciation for investors to profit. This lack of income can be a drawback for those seeking regular cash flow from their investments.
3) Storage and security: Physical ownership of precious metals requires appropriate storage and security measures. This can incur additional costs, such as safe deposit boxes or specialized storage facilities. There is also a risk of theft or loss if adequate precautions are not taken.
4) Market speculation: Precious metals markets can be influenced by speculative trading activities, which can lead to short-term price distortions. Investors who try to time the market or engage in speculative trading may face challenges and risks associated with market volatility.
Another extreme argument typically heard for owning gold and silver is that in the event of a fiat currency collapse, people will be exchanging these precious metals or other commodities as a means of transacting to buy and sell goods. Honestly, I think if we ever get to that point of having to resort to physical gold to buy my food and clothes, there will be much worse things to deal with on planet earth other than how we should be investing our money.
Furthermore, looking at the historical performances of owning precious metals, either physical or digital via an ETF, showcases a gloomy story:
Table 1: Historical performance comparison of S&P 500 against Gold and Silver (June 9, 2023)
Historical performances of metals like gold and silver are quite poor when compared to the average S&P500 returns over a long period of time. Storing wealth in a lot of these investments is actually a losing strategy more often than not, and more so over a long period of time. What is typically thought of as a safe haven for investments is actually a sure-fire way to lose purchasing power over time.
Investors who refer to themselves as gold or silver bugs can enjoy perpetual returns that vastly underperform the US market index. This strategy is part of the Perma crowd of investors that are always touting the same niche investment narrative, regardless of the present economic conditions. Perma bear, perma bull, perma-crypto, perma-gold, perma-whatever…. this “perma” way of thinking or bias leads investors to thinking one directionally and never adjusting from their “perma” position. This can be very dangerous since markets change over time. As technology, society, and consumer preferences change, markets will go through constant cycles of growth and recession, sector rotation, and adjusted sector weightings in indices to respond to such macroeconomic shifts. What once was a great investment 30 years ago may not even have a market for it today (Blockbuster and Toys R Us come to mind). Staying one directional or singularly invested in one sector or niche area over time ignores inevitable changing market conditions, which actually adds more risk to what was initially thought of as a safe haven low risk investment such as gold or silver.
Now don’t get me wrong, being a permabull on overall markets isn’t a fault. This is actually one of the only permanent strategies that makes sense over a long period of time. But narrowly focusing on one specific company, sector, industry, or commodity is very risky because of the severe lack of diversification you have, and less probability of being able to weather the ever-changing economic conditions and drivers of financial markets over time.
It is important to note that if you do really want to invest in precious metals, that is totally fine! Investing in precious metals CAN be part of a well-diversified investment strategy tailored to an individual's financial goals, risk tolerance, and time horizon. Consulting with a financial advisor can provide personalized guidance based on one’s specific circumstances.
Now that is a perma-smart idea.