Investors are Eyeing Gold, But Should Think Twice
Gold is back in the headlines, as prices have jumped to record highs. As of last Friday, the front-month futures contracts for gold closed at $2,071 a troy ounce, which meant gold prices exceeded their peak reached in August 2020 (at the height of Covid-19 uncertainty).
This move has gold enthusiasts clamoring over the investment benefits of the precious metal, particularly at a time when fears over rising deficits and ballooning interest payments have many concerned about the U.S.’s fiscal situation. It’s also true that markets are starting to price in interest rate cuts sometime in 2024, with inflation-adjusted bond yields in decline as a result. Since no-yield gold would arguably have less competition in a falling rate environment, many investors see this factor as giving gold a bit more ‘shine.’1
My message here is to think twice.
For one, if we strip out the impact of inflation on gold’s rising price, i.e., we find that gold is still about 13% below its 2020 peak (as of the end of November) in real terms. Second, if we are to believe that falling rates are good for gold looking forward, then we should expect that the historical correlation between gold and interest rates – as measured by the 10-year U.S. Treasury bond – should be close to -1.00. In fact, since 1973 when gold started trading freely in the open market, the correlation is less than -0.10.
When considering gold as an investment, there’s simply no comparison to stocks’ performance over the long term. Not only has gold been highly volatile over time, but U.S. stocks’ outperformance of gold since the early 1970s is nowhere near a close race. From 1973 – 2022, the geometric average historical return for gold was 6.91%, compared to the risk-free return of 6.12% for 10-year U.S. Treasury bonds. For stocks, it was 10.24%.
For investors seeking to generate solid positive returns from investment in gold, it’s all about precision timing – a very difficult feat to achieve. Getting gold decisions right in the mid-70s and mid-80s would have paid off, and going long in 2005 but getting out in 2012 would have generated strong returns, too. But many other periods over this long-time span would have generated lackluster or negative returns often with volatile rides, a less than desirable outcome for investors. For instance, over the last 10 years, the geometric average historical return for gold was a paltry 0.96%, while for stocks it was 12.44% over the same time frame.
As for gold’s new all-time high, it’s important to point out that in all the time it took gold to surpass its August 2020 high mark, stocks as measured by the S&P 500 are up over +40%. In that time, we know corporate profits have risen strongly and that a tremendous amount of new value has been created in the economy. Buying stocks gives investors a share in that earnings growth while buying gold does not. Gold does not generate earnings, pay investors a yield, or even have many industrial applications. I’d make a similar argument about cryptocurrencies.
A person could certainly choose to try and time investment decisions on when to get in and out of gold, but history suggests this is not an optimal approach.
Conclusion
Over time, gold’s performance simply does not hold up relative to stocks, and I would argue that bonds offer far better risk-adjusted returns given gold’s historical volatility. This is not to say that gold cannot outperform going forward – it certainly could. But a few realities remain that might inhibit gold from becoming a better investment than stocks:
• Gold doesn’t generate earnings;
• It doesn’t pay dividends;
• It doesn’t create new products or services that add value to the economy; and,
• It hasn’t consistently, over time, delivered long-term attractive returns to investors.
At the end of the day, gold might be a useful asset in small allocations for diversifying a portfolio – maybe. But investors should use caution if or when considering it as a major investment holding, in my view. Gold is an asset with historically high volatility and relatively weak returns.
Disclosure
1 Wall Street Journal. December 5, 2023. https://www.wsj.com/livecoverage/stock-market-today-dow-jones-12-05-2023/card/gold-prices-looked-brighter-in-2011-and-1980-5ZbluD61VnmVwua9nRpl?mod=lctimeline_finance
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