Gold has started to rise lately, and with inflation still running hot, we know conversations will shift to gold before long. Gold has been used for centuries to protect wealth and diversify portfolios, with a reputation as a safe-haven asset. Still, it hasn’t always lived up to that reputation. Is now the right time for gold? It depends.
One of the primary benefits of investing in gold is its ability to provide a hedge against inflation. When inflation rises, the logic goes, so does the price of gold. This can be particularly beneficial for investors who are concerned about declines in other asset classes when inflation flares.
However, there have been periods of high inflation when gold hasn’t been so great. In fact, just last year inflation ran at 6.5% while gold barely budged. Gold was a strong inflation hedge in the late 1970s, rising to a record high. Though, in 1980, as the Fed raised rates to combat inflation, gold fell by more than 30%.
Over time, the correlation of gold to inflation has run at only around 38%, meaning the relationship between inflation and gold price changes has been fairly weak. So, while gold sometimes works to hedge inflation, it isn’t as reliable as we’d like. Over longer, multi-year periods, the story is even worse. From gold’s inflation-adjusted high in February of 1980 to its inflation-adjusted low in March 2001, gold lost 82% of its value in real terms. Not exactly a protector of purchasing power.
The same is true with stock market downturns. During times of economic crisis, investors often flock to gold as a safe-haven asset. This was particularly evident during the early phases of the Global Financial Crisis. Gold initially skyrocketed in 2007 as investors sought to protect their wealth. However, as the crisis unfolded, gold fell almost 30% peak-to-trough in 2008.
In our opinion, the biggest detriment to gold is that it has been so volatile. Declines of 30% to 50% have not been unusual throughout history. Global events, economic news, and investor sentiment can all weigh on gold in unpredictable ways. In 2013, for example, the price of gold dropped 28%, largely due to concerns over the Federal Reserve tapering its quantitative easing program. Will the Fed cut rates if we have another financial crisis? Will gold then rise or fall? No one knows.
Gold’s returns for long-term investors haven’t been that great, and the short-term volatility can be substantial. Gold is, therefore, probably best used as a shorter-term trade rather than a long-term investment. And that can be problematic if you don’t believe in market timing.
If you believe in market timing, now may be a good time to buy gold. Gold is usually priced globally in US dollars, so a weak dollar can increase demand for gold as it becomes cheaper for investors in other currencies. We saw this scenario play out in 2020 when gold prices surged by over 25% as the US dollar fell to multi-year lows.
There is certainly plenty of evidence that the US dollar could be in for a tough time in the coming years. If that transpires, it would not be surprising to see gold rally from here. However, it’s important to reiterate that there are other factors at play as well. Inflation, interest rates, and geopolitical events can all influence the price of gold, so again, it is impossible to know which factor will be most important at any particular time.
There are ample reasons why we haven’t used gold in our portfolios in the past. However, we realize the world may be changing and it could make sense for some investors to have shorter-term exposure to gold as part of their alternative allocation. If you think gold could be a fit for you, give us a shout and we’ll discuss in more detail.
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