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Is gold worth its weight in your portfolio?

It's been a great year for gold, with prices up around 25%. That upward momentum isn't a new phenomenon; gold has had its peaks and valleys over the decades. After 30 years of mostly flat prices, gold shot up in 2001 after 9/11 and peaked again at US$1,800/ounce after the 2008 Financial Crisis. Between 2011 and 2019, gold prices declined steadily to about US$1,200/ounce. This started to reverse in August 2019, with the metal reaching another all-time high (over $2,070/ounce) earlier this month.

Whenever gold hits these notable highs, I start getting the same questions from investors – “is gold a good investment?” and “is it a good time to invest in gold?” As with most trendy investments, people tend to ask the wrong questions about gold. Rather than focus on gold as a good investment or timing, it’s more useful to understand the fundamentals of gold, it’s behavior, and how it could work in your portfolio.

As rich as Croesus: A quick history lesson

Unlike other commodities, gold has fascinated mankind since the beginning of recorded time. Because it doesn't degrade or corrode, it retains its value better than other metals and of course, it's really shiny.

Gold has been used as a form of currency since 550 B.C. when King Croesus of Lydia struck the first coins in what is now present-day Turkey and it was the main currency of many countries (along with silver) before the transition to paper currency.

By the late 1800s gold was tied to the value of money through the “gold standard" which ensured that gold reserves were on hand to back a country's money supply. After the 1970s, the U.S., under President Richard Nixon, unlinked the U.S. dollar from gold thereby ushering in floating exchange rates and effectively established the U.S. dollar as a reserve currency.

Some might say the recent jump in the price of gold is linked to the significant increase in U.S. and global monetary supply and the resultant potential for higher inflation. But looking back over the last several decades, there has been no concrete connection between gold prices and higher inflation. For a 20-year period starting December 1983, the price of gold was essentially flat with an average inflation rate of 4% during that time period. From 2004 onward, inflation was much less (around 1.3%), yet gold prices went up a cumulative 400%. Most recently, economists Claude B. Erb and Campbell Harvey put to rest the inflation argument impacting gold prices in their 2019 paper.

Increasing demand has driven the price of gold up

If the last 30 years have shown us anything, it's that gold demand plays the biggest role in its price. This inherently makes sense given the unique characteristic of the precious metal; unlike commodities such as oil, you can't consume gold – supply is fixed to what is currently in circulation and what is available to mine.

Today's drivers of gold demand can be traced back to mid-2019, at the height of tensions between the U.S. and China. As the U.S. began enacting sanctions, countries like China, Russia and several other emerging economies began selling U.S. dollars and stockpiling gold. In the first half of 2019 alone, both China and Russia added 170 tons of gold to their reserves – a trend that has persisted since. It’s interesting to note the inverse relationship between the price of gold and the U.S. dollar as a weaker greenback makes gold more affordable for non-U.S. countries, increasing demand even further.

As the next domino to fall, other market participants (reacting to this buying activity and increase in price) started to load up on gold exchange traded funds (ETFs), further increasing demand and price. In July alone, gold-based ETFs added 166 tons, generating eight consecutive months of positive cash flow into the asset class.

With the COVID-19 pandemic entering the equation, investors started to seek out safe haven assets in response to the economic uncertainty. The U.S. dollar has often played this role, but given the current geopolitical situation, many of these investors shifted to gold as an alternative, again boosting demand and price.

While geopolitical tensions and the mid-pandemic environment could keep pushing gold prices higher in the short-term, the reality is that gold prices have been historically volatile. The outcome of the U.S. election and/or a potential change in geopolitical relations could impact how things play out. As fears subside, demand for gold should stabilize and it could stay that way for some time. We saw something similar playout during the 20-year period of stability between the mid-1980s and the early 2000s.

Don’t go all in on gold, or anything else for that matter

As part of a well-diversified investment portfolio, having some exposure to gold can be recommended. In fact, most MD clients already have some exposure to gold.

The MDPIM Canadian Equity Pool and the MD Canadian Equity Fund have indirect exposure (through gold miners) with allocations of 9.8% and 9.9%, respectively. The MDPIM Strategic Opportunities Pool has an allocation of 12.2% and the MD Strategic Opportunities Fund with 12.1% both featuring indirect and direct exposures.

For more information about gold exposures at MD, how your portfolio is positioned, or to get help assessing investment options, please contact your MD Advisor. She or he would be happy to assist.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.

 

About the Author

Jean-Francois Bordeleau is Senior Practice Manager at MD Financial Management. JF is an advisor to MD Advisors and is responsible for educating them on MD's investment standards and principles as well as MD's investment solutions.

Profile Photo of Jean-Francois Bordeleau