Gold – a safe haven, or too hot to handle?
The spike in the gold price has every man and his dog interested in investing in the yellow metal. Is this a good idea? History may provide some context.
Financial market moves in 2020 can best be described with one word – unprecedented.
Equity markets experienced one of the sharpest and speediest declines in the first quarter, only to recover most of these losses in the four months to the end of July.
One of the most significant winners year-to-date has been gold. The price has risen 30% in US dollars since the beginning of the year (to the end of July), making it one of the most talked about trades of 2020.
This has driven the performance of gold counters listed on the JSE – many of which are up more than 100% since the beginning of the year. Even long-term gold cynic Warren Buffett made headlines recently when it was announced that his company, Berkshire Hathaway, added shares of Barrick Gold to its portfolio in the second quarter of the year.
Gold has a long history as a safe haven investment. This is largely since the price of gold is independent of other asset classes, which means it has generally performed well during periods of market stress or volatility.
Gold has also traditionally been a refuge against US dollar weakness, due to the inverse relationship between the world’s reserve currency and commodity prices.
Historically, gold has excelled during periods of significant market declines and periods of unusually high market volatility.
The behaviour of gold during the Covid-19 sell-off provided an interesting case study, in that although gold fared better than stocks, it still posted a small loss. This has been attributed to many factors, including the fact that the sell-off was liquidity driven (and therefore all encompassing) and the feeling that interest rate cuts will support the US dollar (a negative for commodity prices).
Gold did reverse course, moving higher in the months following the market selloff, reaching a peak of just over $2,000 an ounce.
Despite being regarded as a hedge against inflation, it is interesting to note that gold’s record of protection is rather mixed. The metal did provide significant protection during the high inflationary period of the 1970s. During more muted periods of inflation, including the early 1980s and between 1988 and 1991, gold delivered negative returns, lagging equity markets in the process.
Given the unprecedented levels of fiscal stimulus delivered by major central banks and governments in response to the pandemic, concerns have been raised that this may lead to a significant uptick in inflation.
While this may be true, the evidence suggests that gold’s role as an inflation hedge may be overdone and that there is no guarantee that the metal will provide protection if inflation becomes a problem.
This begs the question, does the introduction of gold improve risk-adjusted returns?
Depending on the period in question, substituting equity allocations with an allocation to gold has reduced volatility and improved risk-adjusted performance.
But note that the results are largely period dependent. In some cases, total returns, risk and/or risk-adjusted returns were improved, however, the results are not conclusive enough to indicate that adding gold allocations to a portfolio will always be beneficial.
What can we conclude about gold? The introduction of gold in a portfolio is not guaranteed to improve risk, returns or riskadjusted returns for every period. Rather, its track record is mixed, and gold can go through long periods of underperformance.
In my view, it should be seen as an insurance policy rather than a core holding. Investors should also be wary of the hype currently surrounding the price movements of gold. DM168
Michael Kruger is an investment analyst with Morningstar Investment Management South Africa