Is gold a good investment? It’s a question that has split the investment community of academics, analysts, journalists, professional and DIY investors for time immemorial. There is an almost religious zeal to the reasoning of more extreme pro-gold advocates – largely founded on apocalyptic scenarios of total collapse of the incumbent economic system and financial markets.
There is also a school of thought that is very much against holding gold – largely founded on the fact it has no income earning qualities and little utility outside of the cultural habit of it being used in jewellery and other aesthetic applications. The middle ground is that gold, on the basis of its historical record of gains during particularly volatile and bearish market conditions, can act as a valuable ‘balancer’ in an investment portfolio. A little like investment grade bonds but with more volatility and greater potential for larger gains and losses.
And gold is making something of a comeback. Investor nerves have seen the highest inflows into precious metals ETCs (Exchange Traded Commodity funds) since 2016. Despite a continuing bull market for equities, worries over signs the global economy is slowing, the U.S.-China trade war and the extensive international quantitative easing raising concerns around the stability of the monetary system has meant a degree of caution around risk exposure. The result is growing portfolio allocations to precious metals, particularly gold, which has recently hit 6-year price highs.
The liquidity and low cost of ETCs, usually backed by physical bars of metals held in vaults, means they have been the biggest beneficiaries of the current trend. They are a much more reliable reflection of gold and other precious metal prices than shares in miners, which are also influenced by a myriad of other factors. And are more convenient and liquid than taking physical ownership of bars or coins.
But let’s take a closer look at the arguments for and against an allocation to gold or other precious metals as part of a diversified investment portfolio.
The Case Against Investing In Gold And Precious Metals
The crux of the argument against ‘investing’ in gold is that many simply do not consider it to be an investment based on how they define the term.
Lack of Fundamentals To Base Value On
If the value of an investment is based on fundamental drivers such as future earnings, profits, expenses, demand from industry etc., there are no such fundamental drivers to the price of gold. Yes, the cost of getting it out of the ground can be considered an overhead. But what influences demand? Gold naysayers say nothing but the emotional whims of speculators who fear a complete breakdown of financial markets.
Even other commodities such as energy commodities, industrial metals and soft commodities, which also don’t have income-earning qualities, have relatively obvious drivers of demand as they are used in fuel, manufacturing, infrastructure and food products.
Gold Is More Volatile Than Bonds But Doesn’t Compensate With Better Returns
Another argument against gold is that as a safe haven investment it doesn’t stand up well to a comparison with low-risk investment-grade bonds. An extensive 2013 study found that over 40 years ending March 2013, gold returns were roughly in line with the main fixed-income benchmarks and almost exactly the same as 5-year U.S. Treasuries.
But gold prices are far more volatile than bonds so the risk profile is much higher. Why take on that extra risk when long term returns have proven to be no better?
Gold Is Not Really A Safe Haven ‘Insurance’ Investment
A common argument in favour of holding gold is that it is an ‘insurance’ policy against a serious market crash or the even more extreme scenario of a total collapse of the incumbent monetary system. The counter argument is that there is no guarantee that the price of gold will show anti-correlation to mainstream financial instruments. Gold’s value against the dollar showed almost no gains during the 2008 financial crisis – the worst since The Great Depression.
It did start to gain at the very end of the year and returned over 150% between November 1st 2008 and its recent high on 23rd of August 2011. In 2019, despite gold returning to a 6-year high over the summer, around a third of those early gains would have been lost if an investor had held on to the precious metal.
The S&P 500, meanwhile, started its own recovery just over three months after gold prices had started to rise. That bull market has continued until now and the index has returned around 335% since. So there was only really a window of a few months after the 2008 crash when gold offered better returns than equities – and taking advantage of that short period would have meant timing the market almost perfectly.
If gold prices didn’t leap during the worst period of the crash and actually showed close correlation to equities – what kind of ‘crash’ insurance does it really offer? Not, it seems, a very reliable one.
The Case For Investing In Gold And Precious Metals
There are still enough investors, both private, institutional and in the form of national reserves, holding gold to suggest the case against the precious metal is not a clear cut one.
Gold As A ‘Safe Haven’ Investment
The most common reasoning behind holding gold is that it is a safe haven investment. This is generally defined as asset that generally holds or increases its value during periods of economic uncertainty and downturns in equity markets. Safe haven investments should preserve capital against market volatility during corrections and crashes. At least to a significantly greater extent than other asset classes.
Does gold answer to that criteria? Morningstar director of equity research, basic materials Kristoffer Inton, describes gold’s relationship to equity markets as follows:
“Looking at the changes in the real gold price and real GDP growth quarter over quarter since 1990, we see that changes in the gold price hold a weak relationship to US GDP growth. We believe this provides evidence that gold is a decent hedge to US economic cycles.”
“Looking at the changes in the gold price and S&P 500 quarter over quarter since 2000, we believe the gold price’s weak relationship to the S&P 500 provides evidence that gold is a decent hedge to equity markets. We established that gold’s functional purposes, including for investment purposes that include safe-haven viability, should be sustainable in the long run.”
The conclusion is that Inton does see some merit in holding gold as a safe haven investment, based on historical evidence. Even if, like during the 2008 crisis, is doesn’t necessarily return strong gains, it also doesn’t tend to lose value during strong bear markets.
Gold As A Dollar Hedge
Another Morningstar analyst, Dan Kemp, the market data and analysis company’s chief investment officer for EMEA, looks at the argument that gold offers a good hedge against the U.S. dollar:
“During the massive drop in the value of the US dollar from 2002 to 2011, real gold prices rose more than 600% from $250 per ounce to $1,500 per ounce”.
“Similarly, a rise in the value of the US dollar after 2011 saw real gold prices drop more than 30% to almost $1,000 per ounce. Given the apparent negative correlation, gold appears to be a decent hedge to the US dollar.”
However, during other periods of time the reverse correlation has been less pronounced. The conclusion reached is:
“While gold isn’t a perfect hedge, there is some empirical evidence that it provides a hedge against the US dollar. However, we are reluctant to declare any kind of direct or causal relationship”.
“We suspect that rather than the US dollar affect the gold price, the relationship is actually the result of being affected by similar macroeconomic factors, such as inflation and interest rates.”
Weighing up the arguments for and against gold as an investment does seem to lead to the conclusion that there is a stronger case against holding the metal than for doing so. However, there is a historical pattern that suggests gold can offer a level of safe haven shelter during bear markets and crashes. And that it can also offer some kind of dollar hedge. However, as an ‘investment’ that offers value-indicating fundamentals such as cash flow, gold comes up short:
“As these commodities have no intrinsic value, returns are governed by the balance of demand and supply together with the degree of speculation present in the market”.
“These factors are all extremely difficult to predict and as a consequence, investment in this area has a low probability of success.”