Since the late Bronze Age, Gold has been seen as valuable commodity by civilizations round the world. It has been used as a symbol of wealth, a form of currency and, more recently, as an intrinsic part of many tech devices. Although it no longer backs the US dollar, it still carries significant importance in modern society. For investors, now may be a vital time to familiarize yourself with the benefits it can bring to a portfolio. In this article we explain why.
Why and when do people invest in gold?
Gold is, ultimately, a hedge against inflation. As inflation rises, the value of a currency goes down because the fiat currency loses its purchasing power. Gold is seen as a store of value, and as such people are encouraged to buy it when their local currency begins to lose its value. It is also one of the few assets that people invest in that is tangible. This helps to give gold a perception of safety for many investors.
This perception is even more pronounced when the US dollar starts to see a decline. Despite being the world’s most important reserve currency, when the US dollar’s value falls against other currencies it prompts a flock of investors to seek the security of gold.
Because gold is priced in US dollars, investors must sell their dollars to buy gold. This then drives the value of the dollar even lower, which in turn also makes gold cheaper for investors who hold other currencies. As a result, we see greater demand for gold from investors who hold currencies which have grown in value relative to the US dollar.
Gold also sees a spike in investment during times of uncertainty. In an environment which is gripped by trade wars, Brexit uncertainty and rising geopolitical tensions, as we see today, people flee to its relative safety. This has led to gold often being called the “crisis commodity”.
Additionally, unlike investing in other real assets like property, investments in gold can often be liquidated much faster. This can provide the same diversification benefits without the added liquidity risk. This, in turn, can help to reduce the overall portfolio volatility.
What is the relationship between the gold price and the stock market?
The accepted wisdom in that gold has a negative correlation with the stock markets. Through certain periods in history, gold has been shown to outperform stocks and bonds, whilst in other periods the reverse has happened.
So why does this happen?
Broadly speaking, when there is a boom in the stock market, equities, as an asset class, become more attractive and people try to invest more money in the stock market. Because most people have limited resources with which to invest, at times like this they will invest their money in equities and there will be less to invest in gold.
However, when there is a crash in the stock market, people are less willing to put their money in equities and instead find other asset classes, like gold, to be more attractive investments. Hence the negative correlation.
This is far from an exact science and, ultimately, the relationship between gold and the stock markets is a fluctuating one which can change quickly.
How safe is investing in gold?
Investors must be aware the price of gold can be volatile in the short term; and that volatility is very much the norm. Over a 40 year period the price of gold has varied to a greater degree than that of the US market. However, it has always maintained its value over the long term. If gold is used as part of a larger, more diversified investment plan, it is not only safe to own but can provide positive returns when the rest of the portfolio is struggling.
Gold is used primarily for jewelry, which makes up around 50% of gold demand. A further 40% of demand comes from the physical investment of individuals, central banks, ETFs and other similar products. This means that around 90% of gold demand is based on its intrinsic value, unlike, say, currencies, which are now backed by the promise of a government to make good on its obligations.
The fact that gold is a finite resource also adds to its value. No one will be making any more of it, thus its physical nature provides its intrinsic value. By contrast, if the US government wants another dollar, it can just print one.
Is this the right time to invest in gold?
We know that gold tends to increase in value in times of economic or political uncertainty, but how does it compare to the markets in those times? If we look back over the last 15 years, a time period which includes the Global Financial Crisis and its aftermath, the compound annual growth rate (CAGR) of gold was 8.82%. On the other hand, the CAGR of the S&P 500 was just 6.52%. Gold has achieved this with lower annualized volatility too.
Recently the US Federal Reserve, along with other major central banks around the world, has been restarting the process of quantitative easing (QE). This involves the lowering of rates in order to stave off a recession and keep growth alive. This will likely increase the US monetary base substantially over the next few years. For example from 2008 to 2015, the monetary base surged from roughly $800 billion to $4 trillion, partly as a result of QE. During this time the price of gold tracked this increase. When the Fed eventually normalized and decreased the monetary base, the price of gold tailed off. This may be a good indication of times to come should QE persist again.
How, what and where to invest in the gold market?
If you did decide that now was the time to invest in gold, there are a number of ways to do this, depending on your requirements and resources.
Physical gold coins or bullion: Although investing in this way is the most tangible, there is likely to be a huge mark-up on the price of the gold coins, bars or jewelry. You’ll also need to find a way of storing it and keeping it safe, which can be costly. Furthermore, you will have to find a market to trade it through which can end up costing you more in fees.
Exchange Traded Commodity (ETC): ETCs are often considered the next best thing to owning physical gold but, unlike physical gold, can be easily traded.
Funds: Perhaps the best way to get a diversified solution, funds are managed by experts who able to exploit both gold price changes and the effect this can have on companies involved in the supply chain. The easiest way to do this is by buying into a fund via an online share buying account.
Shares of gold miners: The shares of these companies will usually track the metal. However, these come with additional risks as mining is expensive, time-consuming and often dangerous. Investors must be aware that investing in shares can be highly risky and gold miners in particular can be very volatile.
Going for gold?
Due to the current market conditions and global unease, investors should certainly consider adding a small amount of gold to their portfolios. This can help increase diversification and, ultimately, the safety of the entire portfolio. Ultimately, if stock prices and a large number of investor’s portfolios are going south, then gold is likely appreciating in value as investors search out safe havens for their cash.