One cannot discuss the history of mankind without referencing gold. Gold has been found in gravesites buried alongside remains as far as 4500 B.C.. Coins containing gold date as far back as 800 B.C.. The first pure gold coins date back to the rein of King Croseusus of Lydia around 500 B.C.. Currencies have come and gone; none can demonstrate the long-standing value of gold. Gold has been woven into the story of humanity as a lasting storage of wealth. The question most investors ask is whether gold still holds this value or is it a historical religion that bares little merit in today’s day and age?
There are several reasons why gold can be beneficial for investors to hold. Gold allows investors to diversify their portfolio, hedge against both inflation and deflation, and protect against geopolitical turmoil. All are viable concerns in the present day.
A key aspect for any portfolio is diversification. Being exposed to one asset class can be lucrative when times are good. It can also be devastating during times of distress. Most investors divide their portfolio between equity and fixed income. Holding gold can provide downside protection if selling in those asset classes occur. Since 2004 the Spider Gold Trust ETF (GLD) has a correlation of 0.33x against the Spider S&P 500 ETF (SPY). That marks a relatively weak correlation and highlights the hedging potential of the yellow metal. Given the volatility in stocks over the past 20 years, gold can provide some protection and a steady return.
Gold can be used as an inflationary hedge. Inflation is an increase in prices that reduce purchasing power of fiat currency. The world has been stuck in a deflationary environment since the 1980s. That is when then Fed Chairman Paul Volcker stomped out inflation by raising rates to 20% in March of 1980. Before Volcker’s aggressive actions, Gold was able to increase over 700% when inflation was rising at double digit rates between August 1976 and January 1980.
Can we see the return of inflation? Aging populations and technological advances have kept prices in check. In the April 2020 Bank of America Fund Managers Survey showed only 10% of survey participants thought that inflation would be higher in one year. This sentiment comes as central banks around the globe are pumping in an unprecedented amount of money supply and governments are increasing fiscal policies to spur a global economy crippled by the coronavirus pandemic. This suggests that fund managers are under exposed to the metal despite a potential wave of inflationary forces. If a vaccine for the virus is found and the markets are sitting on a mountain of monetary and fiscal policy then the three-decade dominance of deflation over inflation could be broken.
Geopolitical events can also lead investors into gold as a haven play. Uncertainty around economic performance and the impact it can have on fiat currency lead to buying in gold. A rise in populism over the last couple of years has led to uncertainty around the push toward globalization. This has led to trade tensions being fanned between the world’s two largest economic powers and disruptions to the global supply chain. This has disrupted economies across the globe and led to fluctuations in currencies. Couple in the never-ending saga in the Middle East, the South China Sea disputes, rising global cybersecurity threats, fears around election Gold allows investors to protect against these moves.
The dual aspects discussed above must be appreciated. Gold can be a good haven protection if the global economy were to come under pressure from the threats on the geopolitical and macroeconomic front. However, it could also prove a beneficial asset to hold if the best-case scenario plays out and economic activity comes back in force with the inflationary tailwind of monetary and fiscal policy in play. Either scenario could be a key driver for gold. Couple in the diversification benefits to fixed income and equities and we can see gold is an asset worth investigating. The next question would be ways to invest in the yellow metal.