Gold prices recently topped $1,500 a troy ounce for the first time in six years, extending a rally that began earlier this year. So, why is the price of gold rising, and what impact will this have on your retirement portfolio? The answer to the first part of this question is complicated.
Several factors are helping to support gold’s recent gains. Among them, global interest rate policies, expectations about the value foreign currencies relative to the U.S. dollar, and the hedging of risk amid rising global uncertainty. An increasing number of gold buyers, from individual investors, hedge funds, central banks, and even foreign governments, believe that the expanding trade war between the world’s largest economies increases the risk of a global recession. A few economists are predicting that if the current trade rift continues, even the current robust U.S.economy will eventually be pulled into a recession.
Unfortunately, the most recent economic data from Europe and the UK have only served to reinforce those fears. German industrial production figures for the month of June were much weaker than analysts expected – a sign that Europe’s largest economy continues to struggle, while another survey from the U.K. showed that the British economy contracted (by -0.2%) in June – the first time in seven years. Neither of these reports was very supportive of global growth or the financial markets.
Given that gold is a commodity priced in U.S. dollars, a rising dollar tends to put pressure on the price of gold, and vice versa. However, there have been times, more recently, for example, when the price of gold and the U.S. dollar have risen together. Global interest rates can also play a role in the demand for gold. As interest rates rise, the general tendency is for the price of gold, which earns no interest, to fall, and vice versa. As a result, gold demand is often impacted by the actions taken by the world’s central banks (U.S., Europe, Japan, etc.) and even by foreign governments as they adjust interest rates in an attempt to control their domestic monetary policies. In fact, many of these entities routinely buy or sell U.S dollars to stimulate their local economies, and a few have been known to adjust gold reserves along with their U.S. dollar holdings to hedge the relative value of their currencies.
So why does the demand for gold tend to increase during periods of uncertainty? Unlike stocks, bonds, paper currency, and other financial assets, gold is a “tangible” asset that maintains its value. It also has zero default risk, which gives it an advantage when compared to financial assets. This may be why gold has been used for millennia to preserve wealth and pass it from one generation to the next. Yet another reason for gold’s popularity is its low correlation with other asset classes – like stocks, bonds, alternative assets, and even other commodities. In 2008, amid the chaos of the financial crisis and global recession, only gold along with U.S. Treasuries delivered a positive return for investors. Perhaps this is the reason we tend to fall back on gold when other financial assets break down, or why many investors view gold as an insurance policy during challenging economic and political times.
Gold – Can It Add Value to Your Retirement Portfolio & What Are The Risks?
Gold can add value to a well-diversified retirement portfolio because it is less correlated with other asset classes. Since it doesn’t perform the same as other investments, the addition of gold can lower the overall volatility of your portfolio. The price of gold also tends to increase in response to events that cause the value of other assets, including paper investments, such as stocks and bonds, to decline. Therefore, gold may help absorb any sudden shocks that might affect other holdings in your portfolio. When used as part of a comprehensive portfolio management plan, owning gold can lower volatility, and over time, even improve the overall risk-adjusted return of your portfolio.
However, the price of gold, like any speculative commodity, can be highly volatile over the short-term, and if used improperly (or for speculation), gold can actually hurt rather than help your retirement portfolio. Most investors would be surprised to find that despite its recent price strength, gold’s performance over more extended periods is well below that of other equally volatile investments, like equities or real estate. However, these assets often generate income in the form of dividends, which enhances the overall return – gold does not. In fact, investors who rushed to purchase gold the last time the commodity behaved this strongly, back in 2011, are still waiting to earn a positive return on their investment – over eight years later! This should be a reminder that the best time to invest in a speculative and volatile asset class, like gold, is when it is out of favor – not when it is reaching 5-year highs.
Anticipating that the volatility the market experienced during last year’s mid-term election cycle would persist, we took the opportunity to add a small, but meaningful allocation to gold across all of our client portfolios – in the form of a low-cost, exchange-traded fund (ETF). However, in some client accounts, depending on suitability, we also made an additional investment in Newmont Goldcorp, the leading ethically and environmentally conscious gold mining company in the U.S.
As political and trade-related events continue to impact our outlook for both the U.S. and the broader global economies, our clients should expect to see gold remain a small, but important part of their retirement portfolios – at least for the foreseeable future.
Recent Comments