Published on November 17, 2023

All That Glitters…The Benefits of Investing in Gold

Gold as a Currency

Gold was first used as a currency in approximately 550 BC when coins were struck in the area now known as Turkey. Gold coins were commonly used until paper money was introduced, at which point most currencies became exchangeable with gold at set values.1 The gold standard ended in 1914 with the onset of World War I, while in the aftermath of World War II, forty-four nations agreed on the Bretton Woods System, a new international monetary system.2 The agreement called for the U.S. to convert any dollars brought by other central banks into gold for $35 per ounce.

The fiat system that we now know began in 1971 when former President Richard Nixon ended Breton Woods and allowed the value of the dollar (and other currencies) to be determined by the free market and backed by the confidence of the issuing government and central banks.

Many currencies are now pegged to the U.S. dollar, and it remains the world’s leading foreign exchange reserve, but that number has been steadily decreasing.3

Benefits of investing in gold

Gold has long been a valuable addition to investment portfolios, with properties including liquidity, low correlation to equities, attractive historical performance, and stability.

Inflation Hedge

The precious metal is also commonly associated with being an effective hedge against inflation. In periods of high inflation, the value of many types of investments erodes as the prices of goods and services increase. With the dollar's purchasing power decreasing, historically, the value of gold has been pushed higher, helping preserve wealth. But was this true during the recent period of rising inflation?

In 2022, inflation soared to multi-decade highs. And while gold barely eked out a positive return, it still outperformed other asset classes and was one of the only asset classes to post a positive return during the year.

Gold vs. Other Asset Classes 2022

Investing in Gold: Gold vs. Other Asset Classes 2022

Source: World Gold Council, 2022 Returns.

Historical returns

Gold has generated returns across longer-term investment landscapes as well. According to the World Gold Council, gold has performed well over both 10-year and 20-year time horizons, outperforming cash, bonds, emerging market stocks, and commodities.

Diversification Benefits

When building multi-asset portfolios, investors should consider how asset classes behave relative to other investments. With a relatively lower correlation to equities as well as cash and other commodities, gold can function as a core diversifying asset in a multi-asset portfolio.

Correlation of Gold vs Other Asset Classes

Investing in Gold: Correlation of Gold vs Other Asset Classes

Source: World Gold Council, Correlation of Gold versus other asset classes, 2017-2023.

A correlation of 1.0 means the asset classes move in the same pattern, while zero equals no price relationship. The closer the correlation to zero, the less likely the asset classes will rise or fall in the same manner.

Investing in gold during uncertain times

Gold is often viewed as a safe haven asset, particularly during times of economic uncertainty, geopolitical crises, or market turbulence, causing investors to flock to the precious metal as a store of value when they are concerned about the stability of traditional financial markets.

The war between Russia and Ukraine had already disrupted the flow of energy and interrupted the export of grains when the terrorist group Hamas attacked Israel, leading to a geopolitical climate that investors have not witnessed in years.

Two of the world’s most well-known finance executives have commented on the severity of the crisis in the Middle East, given the region’s proximity to a substantial supply of the world’s energy.

Jamie Dimon, Chairman and CEO of JPMorgan Chase, stated in an interview with the Sunday Times that "Geopolitical matters are very serious – arguably the most serious since 1938"4 and that the Middle East conflict threatens the world economy. Meanwhile, the head of the world’s largest asset manager agrees. Larry Fink, Founder, Chairman, and CEO of BlackRock, warned that the war in Gaza could spark a global contraction.5

The possibility of a transition from interest rate hikes to a rate pivot could also substantially impact the price of gold. Prices of the precious metal picked up in the spring as investors anticipated the conclusion of the Federal Reserve’s rate hike cycle. In addition to being a hedge against inflation, gold has historically had an inverse relationship with interest rates, and the potential of the Fed beginning a rate-cutting cycle could drive gold prices higher. According to the CME FedWatch Tool, there is a 33% likelihood that the Fed will cut rates in March 2024, and a 64% chance that the central bank will ease by May.

Given its long history of security and stability, investors have sought the safety of gold during past periods of uncertainty to help offset the risk of more volatile assets. During the height of the Great Financial Crisis, gold registered a positive return while most other asset classes plunged.

Relative Price Performance 2008/2007 (% Dec/Dec)

Investing in Gold: Relative Price Performance 2008/2007 (% Dec/Dec)

Source: The Changing Economic and Financial Landscape and Gold.

Central banks and gold accumulation

Investors aren't the only market participants looking to gold — its ability to retain value in volatile markets also makes the precious metal a resource for central banks. Today’s current heightened macroeconomic and geopolitical uncertainty is pushing governments to accumulate the precious metal, with central bank purchases of the commodity year to date up 14% from the same period last year.6

Central Bank Purchases of Gold

Investing in Gold: Central Bank Purchases of Gold

Source: Metals Focus, World Gold Council, September 30, 2023

The U.S. dollar has been showing signs of softening, following a 20-year high in 2022. In times of dollar weakness, central banks often switch to buying gold to diversify away from the dollar. In 2022, central banks purchased over 1,100 tons of the precious metal, the most since 1949, led by emerging market central banks, including Turkey and China, according to the World Gold Council.

Skyrocketing debt has the potential to erode confidence in the U.S. dollar, even as markets have seemingly ignored the downgrade of U.S. debt in August by rating agency Fitch and a recent warning by Moody’s.

Despite China being the world’s largest producer of gold, the country is also one of the biggest buyers. China’s desire to diversify as well as detach itself from the U.S. dollar amid rising political tensions with Washington led the People’s Bank of China to add 78 tons to their reserves in the third quarter, bringing total gold reserves to 2,192 tons.7

Investing in Gold Futures

Current geopolitical events, market volatility as the U.S. Federal Reserve decides the future path of interest rates, and an upcoming U.S. Presidential election add to market uncertainty. Will gold see a further resurgence in 2024? The current gold futures curve is upward sloping (futures prices are higher than spot), on expectations that equities will decline in the near term.

As more investors look to manage risk, trading volume among gold futures is also trending upward. Volume for micro gold futures (rose 68% in the second quarter compared to the same period last year, and demand has increased enough that the CME Group has introduced options on those futures as well.8

Options for Investing in Gold

When it comes to investing in gold, investors have a variety of options:

  • Direct ownership of gold bars or bullions: While tangible, direct ownership presents theft risks, as well as not receiving dividends or interest from the investment.
  • Shares of gold miners: Investing in gold miners also involves careful consideration of geopolitical risks, given that the majority of reserves are located in Australia, Russia, and South Africa, while China is the world’s leading gold mining country.9
  • Speculating on the futures markets: Gold futures allow greater leverage and a more efficient use of trading capital. However, they also involve the risk that losses can exceed the amount originally invested.
  • ETFs: According to ETF.com, there are 35 ETFs traded on the U.S. markets, with assets under management of $109.77 billion.

Outlook for Investing in Gold

After eking out a positive return amid market turmoil in 2022, gold has rallied in 2023, driven by expectations of an end to the Fed’s rate tightening cycle. As investors consider investing in gold, experts are looking at the next phase for the precious metal as the Fed continues to pause and possibly pivot.

With so many options for investing in gold, professional management is essential to determine an investor’s risk level and reward expectations.

Sources:

  1. World Gold Council, Money and Gold.
  2. Federal Reserve History, Creation of the Bretton Woods System.
  3. Statista, Distribution of Global Currency Reserves.
  4. Business Insider, Nov. 7, 2023. “Jamie Dimon warns conflict in the Middle East could trigger the most serious global crisis since World War II.”
  5. WSJ, Oct. 25, 2023. “Larry Fink Says Israel Gaza War Could Cause Economic Contraction."
  6. Metals Focus, World Gold Council, September 30, 2023
  7. World Gold Council, Oct. 16, 2023.” China’s gold market in September: local premium rocketed and demand continued to improve.”
  8. CME Group. “Understanding options on Micro Gold futures.”
  9. Statista, Global gold mining - statistics & facts.

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