The Price of Gold is Rising, But Does it Still Pay to Invest?

Anthony Smith

Data analyzing in commodities metal market: the charts and quotes on display. Gold price analysis. Classic gold volatility against the US dollar.

With a price increase of 29% this year through September 15, gold has been shimmering brightly in 2020. Meanwhile, the S&P 500, a broad measure of stock market performance, was up about 7% during the same period. COVID-related economic contraction and investor uncertainty has kept a lid on stock prices while pushing investors to seek gold.

If you think all the fiscal and monetary stimulus will lead to high inflation, you buy gold. If you are losing faith in the dollar, you buy gold. If you believe the world is ending, you buy gold. Wagering on civilization’s demise has been a losing bet, at least so far, but fears of inflation and dollar debasement may have some merit.

If we could ever vote to retire words, I’d check the box next to “unprecedented.” However, before doing so, let me use it one last time: The stimulus efforts implemented by our government and central bank have truly been unprecedented, resulting in trillions of dollars being injected into our economy. More dollars in circulation can have the effect of reducing the value of each individual dollar. This drives people to buy gold as a store of value.

Also driving the price of gold higher are historically low interest rates on fixed income investments. The 10-year US Treasury note is yielding less than 1%. One of the chief critiques of gold is that it does not generate income for its holders. Fundamentally, investors view assets as sources of future cash flow, which can include interest, dividends, and proceeds upon the eventual sale of these assets. Company stocks can generate investment returns through dividends distributed periodically and perhaps more importantly, through growth in company earnings, which can lead to higher stock prices.

Gold, on the other hand, just sits there collecting dust, waiting for investors to lose faith in other assets. It’s sometimes referred to as a “crisis commodity.” But when a major asset class like bonds are yielding almost nothing, and in fact may not even keep pace with inflation, gold’s lack of income generation doesn’t seem quite so bad.

While the recent surge in gold prices has generated a lot of excitement lately, is it a long-term investment deserving of a large slice of your portfolio? In the five-year period ending September 15, 2020, the price of gold rose 77% to finish at $1,954 per ounce. While respectable, it still trailed the return on the S&P 500 of 90% (assuming dividends were reinvested in the index). Looking back over longer periods of say, 10, 25, and 40 years, stocks have dramatically outperformed gold. It’s not even close. 

It’s the long-term under performance of gold that has cemented its status as a fringy asset class. It just doesn’t have the track record. And if you’ve ever visited websites hawking precious metals like gold, you’ll agree they often appear to have been developed by third graders and maintained by conspiracy theorists. Invariably, there’s a headline from a questionable news source about somebody you’ve never heard of, who allegedly called the housing collapse in 2008, and is now calling for a spectacular collapse of the global financial system within months. You may begin to wonder if you even want to be associated with that crowd.

Be that as it may, gold can play a role in your portfolio, just not a starring role like stocks, bonds, and real estate. A prudent way to view gold is as an insurance policy of sorts. The purpose of insurance is not to generate market-beating returns, but rather to protect against risks. In the case of gold, these risks include the very things driving gold higher this year: inflation fears, economic uncertainty, and dollar debasement.

Schedule a meeting with an HFG financial advisor to review your current investments here or call us at (509) 735-7507. To learn more about our firm’s investment philosophy visit our Portfolio Management page.

An allocation to gold doesn’t have to be exclusive to physical coins either. There is so-called paper gold, which includes gold-backed ETFs that trade like stocks. And then there are stocks of gold mining companies. Many of the large gold miners pay dividends. A very successful and closely followed investor recently became a convert to gold – one Mr. Warren Buffett. Previously, he had long been very critical of gold, once saying, “The magical metal is no match for the American mettle.” Mr. Buffett’s Berkshire Hathaway bought shares in a gold mining company in the second quarter of this year. Score that as a win for gold’s cheerleaders.

A well-diversified portfolio benefits from investments whose prices move in different directions in a given period so that the overall portfolio value doesn’t swing too wildly. Gold provides that diversification benefit. Just be sensible so that when gold falls out of favor again, it won’t remove the luster from your nest egg.  

Anthony Smith, CFA