Introduction to Gold as an Investment
For centuries, gold has been considered a store of wealth, holding its own through economic cycles, geopolitical stresses, and other upheavals. It often attracts attention during periods of uncertainty, when investors are looking for a hedge against traditional assets. Unlike paper or fiat currencies, which are government-issued and not backed by anything, gold is a tangible asset that isn’t tied to any one economy or government.
Why Gold is Attractive
Policymakers don’t control its supply, nor can they print more of it or erode its value. Gold often shines during periods of higher inflation, such as during the 1970s, when shares, bonds, and real estate couldn’t keep up with rampant price increases, and investors went backwards in inflation-adjusted terms. Gold, like the broader commodities space, was one of the few things that performed well, with prices surging 14-fold over the decade.
Factors That Influence Gold Prices
Lower interest rates are also supportive for gold, especially the “real” interest rate, which is the interest rate less the inflation rate. That’s because unlike shares, bonds, or property, gold doesn’t offer investors any income. When interest rates are high, there’s a bigger opportunity cost to holding a non-yielding asset like gold. When interest rates are low or falling, investors don’t forego as much, which makes it more appealing. Weaker currencies also have a positive impact on the gold price, particularly the US dollar, which is the benchmark currency for gold pricing.
Recent Performance of Gold
Interest rate cuts are back on the agenda in the US, while the greenback has weakened from the 20-year highs it reached in late 2022. Central bank buying has also been strong this year, and for the first time since 1996, gold represents a bigger share of central bank reserves than US Treasury bonds. Exchange-traded funds (ETFs) backed by gold saw inflows of more than US$5bn in August, and this year has been the strongest on record outside of 2020.
Gold as a Long-Term Investment
Looking back over the past 30 years, gold has delivered an annual return of 8.0% (in NZ dollar terms). That’s ahead of domestic fixed income at 5.3% and house prices at 6.0%, but behind domestic shares at 8.5% as well as US shares (in NZ dollars) at 10.9%. Gold has also been more volatile than those traditional asset classes, while negative returns have come much more frequently. Those are important points, if you’re considering investing in gold.
Diversification Benefits of Gold
However, if you take a typical 60/40 portfolio (with 60% in shares and 40% in fixed income) and add a small allocation to gold (let’s say 5%), the results are interesting. The return over that 30-year period increases marginally, while volatility falls and the weakest 12-month period improves. Gold tends to move in the opposite direction to other assets, which makes it a useful diversifier. While that’s not always the case, it often is during rough periods.
Real-World Examples
The three worst years for a typical portfolio in recent decades have been 2022, 2008, and 2002, all of which came in the wake of US recessions. Your typical portfolio would’ve fallen about 10% in each of those calendar years, give or take. In contrast, gold (in NZ dollars) went sideways in 2002, rose 40% in 2008, and was up 7% in 2022.
Investment Advice
If you’re considering gold, my first suggestion is to get some advice. My second is to think of it as a component of a portfolio rather than a standalone investment. It doesn’t provide any income and it isn’t without risk, so don’t go overboard. Some of the recent tailwinds could quickly turn into headwinds. The Fed might choose to ease policy more slowly than markets expect, geopolitical tensions could ease, or central bank buying could slow.
Conclusion
After such a stellar run, it’s also possible all the good news is already in the price. However, a small allocation can make sense, providing additional diversification and reducing portfolio volatility without any negative impact on long-term returns. I like to think of gold as an insurance policy, rather than an investment. I’m happy to own a little, whilst also hoping it doesn’t perform very well (as that usually means everything else isn’t).
