Like some investors, you might assume gold stands as a robust and time-tested safe haven. You may think gold can hedge your portfolio against market declines, steady your portfolio during market volatility or protect your purchasing power from the erosive effects of inflation.
In times of economic turmoil, some investors choose to invest in physical gold assets or gold-backed derivatives, from bullion to precious metals exchange-traded funds (ETFs) that offer exposure to physical gold or are pegged to gold prices.
But has gold lived up to its reputation as a safe asset? Is there support in hard data, or is its reputation a product of myth and hearsay? To us, gold’s history and the common rationales for investing in physical gold, bullion or gold-based ETFs or other derivatives don’t stand up to a fact check.
Some investors believe that gold prices are negatively correlated to stocks—in other words, that gold rises when stocks fall, and vice-versa. While it is true that gold does have times of boom and bust, those times do not always correlated with the opposite movement of stocks. Consider that since 1975, world stocks declined in 11 calendar years. Gold rose in five of those years, but fell in the other six.[i] In other words, there is not a consistent inverse relationship. So if you’re looking to invest in gold (via physical bullion, gold mining stocks or precious metals ETFs) to hedge your portfolio during stock market declines, you may be disappointed by the results.
There are also those who invest in gold due to the belief that it can hedge against volatility. But observe Exhibit 1, which shows golds price movements since 1973. Gold has had times of relatively stable price performance, but also times of volatile movement. Further, note that after the 1980 high, it took over 25 years to get back to that pre-drop high. If you’re invested in gold, can you handle underperformance for that long?
Exhibit 1: Gold's Prices and Booms
Source: FactSet, as of 01/08/2019. Gold spot price, monthly, 11/30/1973 – 12/31/2018.
Since gold hasn’t shown a meaningful, consistent lack of volatility in recent history, it is difficult to substantiate the claim that investing in gold might help mitigate the negative effects of market declines on your portfolio.
If gold is not an effective hedge against stock market volatility, what about its long-term returns and intrinsic value?
Is gold a fundamentally more valuable asset that compensates you with higher returns? Over the long term, stocks’ annualized returns far exceed those of the yellow metal. Gold became freely traded in the United States in 1973. From December 1973 through the end of 2018, world equities returned 8.3% annualized.[ii] Over that same time period, gold returned 5.6% annualized.[iii]
Observe Exhibit 2, which shows the growth of $1 since December 1973, in terms of the S&P 500, the US 10-Year Government Bond Total Return, and gold. We can see that gold was the worst performer.
Exhibit 2: Growth of $1: Stocks, Bonds and Gold (December 1973 – April 2019)
Source: Global Financial Data, Inc. as of 05/23/2019. Gold Bullion Price, New York (US$/ounce), S&P 500 Total Return Index, US 10 Year Government Bond Total Return Index from 11/30/1973 – 04/30/2019.
If gold’s price is not fundamentally less volatile or more profitable than stocks, then it doesn’t really make sense as an effective safe haven from stock market volatility. Even when comparing to US 10-Year Government Bond Total Returns, gold underperformed with more volatility! The “hedge” actually seems much less attractive than the risk it is intended to mitigate.
Remember that gold is a commodity, like precious metals or agricultural products. It is a physical product whose prices are driven by supply and demand. Gold supply comes from mining, and demand (both investment demand and commercial use demand) drives price movements. Gold’s price does not come from an intrinsic, fundamental value. Some investors may invest in gold if they fear a disaster scenario—a massive bear market, or some far-reaching stock market collapse. But we’ve already shown in Figures 1 and 2 that gold does not always outperform when stocks underperform, and gold itself can experience lengthy stagnation. And in the case of a true financial collapse scenario, gold does not have inherent properties that mean it will continue to hold significant value. In fact, many other metals have more far-reaching industrial and commercial use.
While it is true that gold prices (and other commodities at times) can have periods of outperformance, do you have the ability to time the market to take advantage of it? Go back to Exhibit 1. Would you have known to avoid gold during the 90s, but jump in and invest before the rise in the mid-2000s? Could you have gotten out of gold before the drop in the 2010s? The stock market also has volatility that makes market timing difficult, or impossible. But as we saw in Exhibit 2, stocks give investors more significant long-term returns in exchange for enduring that short-term volatility. If you can’t time the gold market, and it does not provide better long-term returns, how is investing in gold a safer bet than investing in stocks or bonds?
There’s a difference between investing in gold (e.g., bullion, gold ETFs, the physical object itself) and gold as a symbol. Unfortunately, the latter often wins out in investors’ estimation of value. Gold has an emotional appeal that makes investing in the precious metal more than just a calculated financial decision.
Perhaps gold’s status is a remnant of its long history trailing across centuries of treasure, conquest and sunken ships full of jewelry, coins and bullion. Or maybe gold’s appeal is attributable to factors much more recent—the world’s currencies weren't fully divorced from the gold standard until the 1970s. Either way, the history of gold as a symbol and object of value is significant.
This long history often makes it difficult to separate fact from myth, functional use from emotional appeal and real performance from popular opinion. As a result, people who invest in gold often end up conflating all of the above when they should be focusing on gold’s performance.
Ultimately, successful longer-term investors would be better served by viewing gold for what it really is—a commodity, a shiny metal offering limited inflation or volatility protection and low prospects of growth and return.
[i] Source: FactSet, as of 2/21/2019. Gold annual price return, 12/31/1974 – 12/31/2018. MSCI World annual return with net dividends, 12/31/1974 – 12/31/2018.
[ii] Source: FactSet, as of 1/18/2019. MSCI World Total Return Index with net dividends, 12/31/1973 – 12/31/2018.
[iii] Source: Global Financial Data, Inc., as of 01/18/2019. Gold Bullion Price – New York (USD/Ounce), 12/31/1973 – 12/31/2018.