Despite gold’s recent run, don’t fall for its allure – it is a shining example of what not to buy
Market enthusiasm over the precious metal could set up investors for a fall, writes Taha Lokhandwala
Gold has smashed through a new price record this week, surpassing the psychologically important barrier of $2,000 an ounce. Investors are doing well out of a superb run that has made the metal the best performing asset this year.
It is a perfectly legitimate asset that every investor should include in their portfolio – but there are right and wrong reasons to buy it and the market’s enthusiasm could be setting up investors for a fall.
Let’s start with the reasons behind gold’s rising price. It has increased more than 30pc this year and kicked off its spike in earnest in mid-March, as the pandemic began engulfing the West.
This made sense. Fear had taken over investors and share prices began quickly losing value and the gold price rose. Its use as a safe haven and store of value was evident.
But as markets bottomed out, the gold price continued to soar. Since April, the price has risen 30pc, just below the 34pc rise in the S&P 500.
Gold, seemingly, was becoming less of a “fear” asset.
At that point the price was rising for different reasons. In tackling the economic consequences of coronavirus, central banks and governments unleashed a wave of financial support.
This influx of cash – known as quantitative easing – totalled
$20 trillion (£15 trillion) and is now worth nearly one fifth of the world’s economy, according to Bank of America Merrill Lynch. This was used to buy government and low-risk corporate bonds and fuel financial markets.
Such bonds are traditionally the preserve of conservative investors but quantitative easing had pushed down yields. Some $16 trillion of global debt now has a negative yield meaning new investors wanting an alternative to stocks opted for gold.
The influx of cash can lead to inflation, and markets began pricing in the expectation for higher inflation in the long term. This further undermined the appeal of bonds and the “real rate” (yield minus inflation) became negative for a lot of debt.
Then came the most recent boost, the devaluation of the US dollar. Gold is priced in dollars, but it is not a dollar asset. It is a pseudo currency with no intrinsic value and can only be worth what it is priced in other currencies.
For example, the US dollar has lost 14pc against the pound since April. As the dollar loses value the gold price increases as its worth stays the same – just as one pound is worth more dollars now than it was in April. Ben SeagerScott, of wealth manager Tilney, calculates that dollar depreciation has accounted for about one third of the gold price rise – 10 percentage points.
All this brings me back to my concern with gold. Nowhere in the analysis of why the price is rising did the reason “because it is a good investment” ever come up.
Gold has no intrinsic worth. It is not a business where profits can drive share prices higher. Gold is not an investment where investors can expect income and compounded return. Yet DIY investors have been scrambling to add gold to their portfolios. Figures from Interactive Investor, a broker, showed iShares Physical Gold and WisdomTree Physical Gold were two of its bestselling funds this month.
Gold has a place in a portfolio, a 5pc-10pc allocation to act as a buffer and a diversifier for when stock markets take a tumble.
But unless you’re willing to make short-term trades, and take on all the risk and difficulty that a buying low and selling high strategy brings, then piling into gold now is a mistake.