Over the past five months demand for gold has spiked, thanks to jumpy investors growing ever more fearful of the world around them. Depressed energy prices, perpetual concerns over lackluster Chinese economic growth, and a possible British exit from the E.U all weigh heavily on investors’ minds.
U.S. stocks are up only about 3% after suffering historic losses in January, and first-quarter economic growth reports underwhelmed. Despite all this, the Federal Reserve has hinted it is inclined to raise interest rates in June. (May’s jobs report may render that impulse moot.) Hence the nerves.
In this environment investors have reaffirmed their love affair with gold, sending prices up 15% since January. Have you already missed the run, or is there more room to go? Here’s what you need to know.
Gold is Weird
While all investing comprises some element of emotion, gold is on a different plane—perhaps because of its unique nature. It’s not really a currency, the only people who buy things with gold are on Game of Thrones, and it’s tricky to call it a commodity. After all, what do you use gold for? (Oil, timber, and the rest all have some utilitarian function on which billions of people rely.)
As far as investments go, gold leaves a lot to be desired. The precious metal offers no dividend or interest of any kind. Rather, demand ebbs and flows with people’s views of the world. From the fall of 2008 to 2011, a period marked by severe global recessions and sovereign debt crises, the price of an ounce of gold jumped from about $750 to $1,900. Since then gold has been in a bear market, down 35%, with occasional jumps when the bad news pours in.
Gold is Unpredictable
So should you get in or not? The first thing to understand is that gold, at most, should occupy no more than 10% of your portfolio, per portfolio manager for USAA Precious Metals and Minerals fund Dan Denbow. Its main purpose, after all, is to provide diversification. SPDR Gold Shares SPDR GOLD SHARES TRUST - EUR ACC
gained 5% in 2008, while the market collapsed by 37% and commodities declined 33%.
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Still, gold is unpredictable, often moving quickly and without warning. You may remember that prices fell off a cliff last fall when it became clear the Federal Reserve was going to raise interest rates.
“As gold pays no interest or dividend, the opportunity cost of holding the precious metal is a critical driver of returns,” noted BlackRock’s Russ Koesterich in a recent blog post. “During periods of low or negative real rates, when the opportunity cost is low, gold has generally performed better than in periods when real rates are higher.”
If investors can’t make money by parking their cash in super-safe Treasury bonds, the thinking goes, there’s little harm in holding onto gold, especially since low interest rate periods correspond to times of weak economic growth. Once economies start to pick up and inflation rises, central banks hike interest rates so prices won’t go up too quickly. That’s when gold buyers turn into sellers.
Gold Is No Match for a Diversifed Portfolio of Stocks and Bonds
Making bets on the direction of gold over any period of time, short- or long-term, is generally a mug’s game. For one thing, gold isn’t really an inflation hedge, or at least not in the way you want it to be. Gold may keep its value over centuries—an ounce of gold buys you pretty much the same amount of bread now as it did 2,500 years ago—but its cost will fluctuate widely in your lifetime. Stocks provide better inflation-adjusted returns over the long haul.
“While gold may play a role in a diversified portfolio, it should be seen in part as a commodity, and only in part as an investment that is driven by the desire of investors to protect themselves from financial crises,” according to a 2012 Credit Suisse report.
So if you think the world will experience dramatic shocks in the near term, gold may be an option for you. But limit your stash, and ready yourself for periods of dramatic declines.