Since a recent low of a little over $1076 oz set in December 2015, the price of an ounce of gold has almost doubled to just under $1960. Since the turn of the century 22 years ago, the price of gold has risen around sevenfold. That’s an average return of over 30% a year. Not bad for a commodity asset that generates no income and has limited practical use.
As an investment, gold has its critics. It has also always been a cornerstone asset of investment portfolios. We’ll look at some of the reasons why gold is such a Marmite asset but what is undeniable is that the price of an ounce of gold has risen sharply since 2018 and it isn’t a surprise.
The price of gold has historically risen during periods of uncertainty and volatility in the world. And during periods of higher inflation. We’re currently in a period that ticks both of those boxes and gold hasn’t gone against the grain with recent gains taking it towards record highs.
Some experts have tipped gold to move as high as $2500 oz this year if central bank interest rate rises fail to bring inflation back under control relatively quickly and geopolitical turmoil, particularly Russia’s invasion of Ukraine, doesn’t recede.
The main factors that influence the price of gold
As an investment class, gold is considered a ‘safe haven’ asset and a hedge against inflation. As a metal, gold is too soft to have much industrial use except in electronics where its plasticity and high electrical conductivity mean it’s used in connectors, switch contacts, relay contacts and wires.
The increasing quantity of electronics in the world is a meta trend that will continue to support the price of gold over coming years. But it’s not a big enough portion of overall demand to drive the kind of strong bull market we’ve recently seen for the precious metal. Its biggest price drivers are demand for gold jewellery and as an investment class. The latter accounted for 47% of all gold demand in 2020 and the former 37%. If central bank demand for gold is counted as investment demand, and I think it should be, investment accounts for almost 56% of total demand.
Source: Statista
Demand for gold jewellery tends to rise when economies are strong and especially when the good times roll in India, which is historically the biggest consumer of gold jewellery. Its gifting is deeply ingrained in Indian wedding and other familial rituals. China is the second largest consumer of gold jewellery.
But while jewellery demand does influence the price of gold, it also doesn’t drive the kind of gains the precious metal has seen in recent years. It’s not volatile enough.
Investor demand is far more influential and with the exception of slump between 2012 and 2015 as equity markets roared ahead after the international financial crisis, gold has been in a long term bull market for twenty years now.
Source: GoldPrice.org
Investors have been allocating at least some of their portfolios to gold in growing numbers, driving up prices. One window into investor enthusiasm for gold is flows into ETFs that track the price of gold and other precious metals. When gold prices dropped steeply in 2013, there was also a flow out of ETFs.
There were large flows into gold ETFs in 2019, as many financial markets observers started to worry about the end of the record long equities bull market, and then 2020 as the Covid-19 pandemic struck and there was a brief flight from risk. The rising spot price of gold reflected that.
This year has seen huge flows into gold as markets take fright at the war in Ukraine and impact that will have on global supply lines and inflation, especially in commodities. By late February, even before Russia had invaded Ukraine, data from Refinitiv Lipper reported by Reuters showed gold and other precious metal ETFs have seen an inflow of $4.7 billion after outflows worth $7.8 billion last year.
Why invest in gold
Criticism of gold as an investment is centred on it not earning any income and not having much industrial use, other than in electronics. Its price movement is historically a reflection of market sentiment. When investors are optimistic, gold is shunned in favour of growth companies and other riskier asset classes. When fear grips markets, there is a flight to gold, which is why it is often referred to as a ‘safe haven’ asset.
As a result of its historical behaviour patterns, as an investment, gold is most often seen as a hedge against equities bear markets. It’s a defensive position rather than an offensive one, designed to limit short to medium-term losses. Few investors look to gold as a means of creating wealth sustainably in the medium to long term. It’s generally considered too volatile and a return an equities bull market typically sees it lose its allure and prices drop.
Will the gold price continue to rise?
Given the extent of gold price gains over the past two decades, a sensible question is if gold could still gain enough from its current levels to act as an effective hedge if stock markets continue their 2022 fall.
It’s not a question that can be answered with any great certainty. But if the global economic situation continues to deteriorate this year as a result of the war in Ukraine, and inflation rates remain high or even continue to rise, some analysts believe gold could hit $2500 oz.
However, investors should keep in mind the potential downside. Shortly before Russia’s full invasion of Ukraine, UBS analyst Joni Teves forecast a cooling of gold prices as soon as investors could see beyond the geopolitical crisis.
The Fed raised interest rates recently and expects to up to 7 more times this year in incremental rises of 0.25% in an effort to control inflation. Interest rate rises would be expected to put downward pressure on gold prices, especially if they are proving effective in keeping a lid on inflation.
In February, Teves said:
“We do think prices can stay elevated as geopolitical risks linger. But our expectation is that ultimately, as geopolitical risks fade, the gold market should revert back to focusing on macro drivers such as real rates, Federal Reserve policy, and the growth outlook.”
If interest rates remain elevated and the situation in Ukraine deteriorates further, gold prices could yet still rise significantly on current levels. But if there is de-escalation in Ukraine and interest rate rises start to pull inflation levels back, the price of gold would be expected to drop. With that in mind, an investment in gold would be a bet on a negative economic and geopolitical scenario persisting throughout 2022 or for at least another several months.
How can I invest in gold without buying physical metal?
It’s possible to buy and store, usually with a third party specialist, actual physical gold. But doing so involves some cost, which erodes gains. For example, the online gold specialists gold.co.uk, charges fully allocated storage fees at 0.65% + VAT per annum of the Insurance value of your total metal holding.
You can also hold non-allocated gold, which means you have the right to a quantity of gold you have paid for at the current spot price. But your money is not necessarily invested in gold by the intermediary, though some of it almost certainly will be. Non-allocated gold is considered riskier as there is always a chance the intermediary could run into financial problems.
However, if you buy non-allocated gold through a regulated and well-established bank or broker, that risk is balanced. It’s also cheaper than holding allocated gold as there is no vault space to pay for.
Gold ETFs
Gold ETFs, or ETCs (exchange-traded commodities) are open-ended exchange-traded commodities funds that closely track the price of a commodity (or basket of commodities), in this case gold, by buying them with investors’ funds. So if investors buy £100 million of units in a gold ETF, the ETF buys roughly £100 million of gold at the current spot price.
Gold ETFs do effectively track the price of gold and their advantage is they can be bought and sold quickly and easily through most mainstream investing accounts, just like shares. And they are cheap to hold.
The largest gold ETF on the London Stock Exchange is the ETFS Physical Gold (PHGP) and the iShares Physical Gold ETC (SGLN) is a lower-cost option with an annual management fee of 0.25%.
If you are worried about the prospects for the global economy in the short to medium term and see exposure to gold price as an investment hedge against that, Gold ETFs are a convenient way to gain that exposure without going to the expense and trouble of holding the physical metal.
