Historically, gold has been used as a store of value. During the Gold Standard currency system, currency could be freely converted into gold at predetermined rates. This meant that the money supply was inherently constrained by the size of a nation’s gold reserves. Given this illustrious history, Gold has not only been traditionally viewed as an analog to currency values as well as solid investment. Gold exhibits many key characteristics that make it an attractive investment and is often viewed as a proxy for broader commodities in the market as it is one of the most easily recognizable commodities. Read on as we take a deeper dive into gold as an asset class:
Gold tends to exhibit the following relationships with other asset classes:
- Gold is typically tied to real interest rates (i.e., nominal interest rates net of inflation) since it does not provide an income yield. Generally, as real interest rates decrease or become more negative, gold becomes relatively more attractive, and vice versa.
- Gold is considered a ‘hedge’ (protection) against a falling stock market. One way to think about this is that in times of market panic, investors tend to flock to gold as a high-quality hard asset, which drives up its price.
- Just as a falling dollar produces higher gold prices, it has the same impact on other currencies. That is, a bull market (upswing) in gold should correspond to a bull market (upswing) in other currency markets.
Gold as protection from extreme loss outcomes:
Gold had entered a bull market (upswing) at the start of 2003, while stocks were in a bear market (downswing). This situation was reversed in the previous two decades. This meant that, for the foreseeable future, gold was likely to be a much better investment than stocks. This proved to be the case, as the global financial crisis of 2009 caused significant equity market declines while gold’s value increased. Similarly, in recent years the price of gold has risen during periods of market volatility.
All that glitters is not always Gold:
Gold is a real asset, one that possesses the necessary characteristics to function as an effective currency and it is often seen as a safe haven in times of market stress. Even though, on a relative basis, it should perform well as a hedge against the stock market, this is not always the case. For instance, during the pandemic-induced market volatility in 2020, the price of gold fell, as investors chose to meet margin calls by selling gold, rather than selling stocks at depressed prices.
The impact of Central Bank policies on the outlook for Gold:
The price of gold increases just like any other commodity, and it is often described as a ‘hedge’ (protection) against inflation. However, the paths and timings of the price increases do not always match. It is more likely that the price of gold reflects investor expectations of Central Bank policies to create or combat inflation; this is why we say the trajectory of gold depends on real interest rates (i.e., the trajectory of inflation in relation to nominal interest rates (with inflation)).
Why have Gold in a portfolio?
As a proxy for commodities, gold is an essential asset in a diversified portfolio as it ensures that the portfolio has high-performing assets. Gold possesses all of the characteristics of an ideal currency. It is scarce, decentralised, not under the control of any third party, and fungible, which means it can be divided into different sized units to facilitate transactions. Lastly, it is portable, even more so than silver, as it packs a ton of value into a tiny package, with a single ounce of gold currently being worth around £1,420.