Although markets have performed well this year, some investors may be nervous about upcoming events such as the presidential election, the Fed’s next rate decision, and the state of the economy.
Along with the uncertainty of the past few years, it’s no wonder that gold prices have also risen to record levels above $2,600 per ounce. While gold can serve a purpose, some investors may focus on it as a standalone investment rather than as a component of a well-constructed portfolio. In today’s market environment, what role should gold play in long-term investment and financial plans?
There are many reasons investors might be drawn to gold.
- As a store of value (especially in inflationary periods such as the one we just experienced).
- During times of political uncertainty.
- Hedge against fiscal deficits and loose monetary policy.
- It can also serve as a safeguard against market volatility when geopolitical risk is heightened, as is the case today with tensions in the Middle East.
While gold can play these roles, the stock market has historically outperformed over long periods, and bonds provide attractive characteristics such as yield and income. Understanding the relationship between gold and other asset classes is critical as markets continue to rally.
The case for gold really depends on the portfolio objective.
Across economic environments, gold can serve at least two investment purposes.
1. First, as a precious metal with consumer and industrial uses, the value of gold can rise over time due to limited supply and steadily increasing demand. This is in addition to demand for gold as a luxury good. As a result, it can serve as a store of value when the world is uncertain and can also protect against inflation as the economy heats up or as central banks increase stimulus, as they have done this year. It’s also clear that many investors flock to gold for safety when markets get choppy. In many ways, this is no different from how some investor’s view cash or bonds – as a tool to protect their portfolio from short-term market swings. Unlike cash and other safe-haven assets, however, gold does not generate any portfolio income. Thus, it’s important to distinguish between gold as a one-off investment and as a part of a portfolio tailored to achieve financial goals.
2. The second and more important consideration is whether gold can help diversify portfolios. Much like bonds, gold tends to perform differently to stocks. The relationship between gold and the stock market since 2008, shown in the accompanying chart, makes this clear. Although gold outperformed stocks during the global financial crisis, it fell in value and flat-lined for years while the stock market climbed to new record highs. Gold also jumped in value during the pandemic, and again more recently as the Fed began to cut rates.
What may be surprising is that gold was relatively flat during the recent inflationary period that began in 2021. This is partly because the Fed raised rates rapidly in 2022, increasing the attractiveness of cash and other short-term assets. This reveals that understanding the underlying drivers of gold price movements and Fed policy is important when it comes to making portfolio decisions.
It’s also important to note that over this full period, the stock market outperformed gold, just as it has against most other asset classes. Of course, constructing a portfolio is not just about investing in the best performing asset – it’s about diversifying to reduce risk and help smooth the ride and to meet financial objectives. While gold may be attractive to investors for a variety of reasons, it’s always important to view it with respect to other asset classes, including stocks, bonds, cash, alternative investments, and real estate.
Why Have Gold Prices Risen Recently?
Gold often performs well when interest rates decline, as lower rates make non-yielding assets like gold more attractive. The Federal Reserve typically cuts rates to boost economic growth, which can signal an economic slowdown or rising inflation—both positive for gold as a hedge against rising prices.
However, falling rates also benefit stocks and bonds. A “soft landing,” where inflation slows and rates fall, can create a favorable environment for the stock market and boost bonds, as higher-yielding bonds become more valuable. Recently, though, market-based rates have risen, with the 10-year Treasury yield nearing 4.1%.
Like all investments, gold is best (if used) as part of a diversified portfolio. Various asset classes, such as international stocks and small caps, have contributed to market performance this year. Rather than focusing on a single asset, building a resilient portfolio to weather changing market conditions is key.
Geopolitics and other concerns will continue to impact markets, the principles of a well-designed portfolio remain steady.
What’s the bottom line?
Gold’s recent rally can be attributed to Fed rate cuts, geopolitical tension, and fiscal concerns. Investing in gold or any investment should always be considered in the context of a designed investment strategy rather than as a standalone investment.
As Led Zepplin so aptly sang:
And as we wind on down the road
Our shadows taller than our soul
There walks a lady we all know
Who shines white light and wants to show
How everything still turns to gold
And if you listen very hard
The tune will come to you at last
When all are one, and one is all, yeah
To be a rock and not to roll
–Paul R. Rossi, CFA