Today’s combination of volatility and lower returns from traditional asset classes means that interest in gold has increased. Our recent conversations with investors have uncovered a number of misguided notions about investing in gold.
If You Think You Know Gold, Think Again Gold has a track record of holding its value or rising when many other assets are falling, adding important diversification to portfolios which has the potential to help risk adjusted returns. Gold’s legacy of diversification and low correlation to many other traditional asset classes has also earned it a more tactical reputation with investors as a perceived “safe haven” asset1 during times of market turbulence and crisis (See Figure 2). And yet, misconceptions about gold persist:
Top 5 Gold Misconceptions
Reality: Since the early days of civilization, gold has been used as a currency and a tangible means for storing and preserving wealth. But skeptics of gold often cite that gold does not provide returns, especially on a long-term basis. That claim is just not true. In fact, from August 15, 1971, when President Nixon removed the US dollar from the gold standard, the dollar gold price has increased 7.65% annualized2 through September 30, 2019. Although gold has not outperformed traditional assets during every market cycle, it has provided a competitive positive return on a longer term basis relative to other traditional asset classes.
Furthermore, the diversification provided to portfolios with a long term strategic allocation to gold may potentially help investors preserve capital and limit portfolio drawdowns during certain periods of market dislocation – a strategy that may be as critical for long term performance as generating returns during other cyclical market scenarios.
Gold has historically performed well in real terms relative to other asset classes under a wide variety of business cycles, a benefit derived from its low performance correlation with many traditional equity and bond markets. In fact, as highlighted below, during periods of market turmoil and large equity drawdowns gold has provided an average 7.18% return, while the S&P 500 TR Index pulled back - 23.48%. In these types of market downturns, risk is not exclusively about managing volatility, but also about minimizing any permanent impairment to capital – and gold has historically exhibited the potential to perform positively under a multitude of disruptive financial and tail risk events.
Reality: Although the gold price can sometimes exhibit significant volatility in the short term, it’s a different story longer term. Gold’s annualized volatility over the last 30 years is 15.44% – not dramatically higher than the S&P 500–which posted a 14.32% annualized volatility over the same period3. Additionally, as Figure 3 illustrates, both gold and the S&P 500 Index rolling 3-year standard deviation of weekly returns have generally stayed relatively close to each other. In fact, the price of gold only significantly outpaced the S&P 500 Index in the late 1970s and early 1980s when inflation was high by U.S. historical standards and the Fed was forced to raise the federal fund rate (upper bound) to 20%.4 In addition, if one considers that indices tend to be less volatile than their individual stock or bonds components, gold’s potential volatility may be less of a concern when compared to individual stocks or sectors. In other words, claiming that gold might be overly volatile relative to equities may be misguided.
For investors more familiar with real asset exposures in their portfolio construction strategy, gold has historically provided lower volatility relative to many other precious metals, commodities and real estate.
Reality: It is true that gold bullion does not provide a coupon payment or a dividend, like bonds and some stocks do. That makes gold different from many other traditional investments, and it highlights a fundamental difference in how investors are compensated for their investment. Stocks and bonds often compensate shareholders by providing some combination of income (dividends) and capital appreciation (returns). But gold bullion – the tangible asset – has no shareholders. Rather, gold investors are compensated purely by price appreciation, which is driven by a diverse and unique set of economic and market factors that influence gold’s price. This may seem like a trivial detail, but it is an important distinction between gold and some of its rivals that may be growing in importance as investors face lower yields from traditional income strategies.
A lower long-term rate environment has created new challenges for asset allocators and traditional income-producing investment strategies. In response, some investors have ventured further out along the risk curve in pursuit of higher yields; but this may not be the right course of action for all. In fact, in this context, gold may look relatively attractive despite it lacking a yield. On average, gold has historically performed well when real interest rates were negative. Additionally, when real interest rates were 2.5% or lower, this also provided an accommodative backdrop for gold to perform well historically. In a low or negative rate environment the opportunity costs associated with gold potentially diminish along with the significance of it lacking a dividend.
Reality: Gold has often been viewed as beneficial only during periods of heightened price inflation – like that experienced during the OPEC oil crisis in the 1970s. But the reality is that gold and inflation don’t always move in lockstep. Gold has historically provided positive returns during periods of low and moderate inflation. Inflation clearly plays a role in affecting gold’s price, but there are other drivers than simply an increase in prices that influence gold’s returns.
Analyzing gold’s price performance since 1970, Figure 7 shows that during periods when the annual rate of inflation in the US has been below 3%, the gold price has risen at an average rate of 5.07% per year. But gold has shown its greatest effectiveness in preserving purchasing power when price inflation has been running above 3% a year. During such times, the price of gold has increased by an average annual rate of 15.05%.
Reality: Gold and the US dollar (“USD”) have a long history of structural and economic ties. But the structural ties were formally severed on August 15, 1971 when President Nixon “closed the gold window”, ending the right for central banks to convert their dollars into gold on demand- the prevailing system under the gold exchange standard initiated by The Bretton Woods Agreement. This officially and functionally delinked gold’s price from the USD and opened the path for the metal’s price to be dictated by open market demand, an event we often refer to as the Initial Public Offering (IPO) of Gold. Further, as the value of the USD has fluctuated relative to other currencies around the globe, the price of gold has been impacted, resulting in the commonly cited negative relationship between gold and the USD. But this apparent negative correlation is a key structural link that should not be confused with the economic factors that can also impact the USD and gold prices. This structural relationship has helped support the commonly cited negative relationship between gold and the USD, driving some to believe that gold will appreciate only when the USD declines. As illustrated below, that is not always the case, with the price of gold influenced by several factors beyond the USD.
Today’s uncertain market environment may be an ideal time for investors to rethink many of their commonly held misconceptions about gold, along with the strategic and tactical advantages an allocation to gold may potentially bring to investment portfolios. GLD offers access to the potential benefits of the physical gold market and its price movements in a convenient ETF structure. For current information about the performance of gold and the SPDR Gold ETFs, click here.
Bloomberg Barclays Global Treasury ex-US Index: A benchmark designed to track the fixed-rate local currency sovereign debt issued by investment-grade countries outside the US. Bonds must have a remaining maturity of one year or more.
Bloomberg Barclays U.S. Corporate High Yield Bond Index: The index covers the universe of fixed rate, non-investment grade debt. Eurobonds and debt issues from countries designated as emerging markets (sovereign rating of Baa1/BBB+/BBB+ and below using the middle of Moody’s, S&P, and Fitch) are excluded, but Canadian and global bonds (SEC registered) of issuers in non-EMG countries are included. The index includes both corporate and non-corporate sectors.
Bloomberg Barclays US Aggregate Bond Index: A benchmark that provides a measure of the performance of the US dollar denominated investment grade bond market, which includes investment grade government bonds, investment grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are
publicly for sale in the US.
Bloomberg Barclays US Treasury Index: US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index.
Bloomberg Commodity Index: A broadly diversified commodity price index distributed by Bloomberg Indexes that tracks 22 commodity futures and seven sectors. No one commodity can compose less than 2 percent or more than 15 percent of the index, and no sector can represent more than 33 percent of the index.
Consumer Prices (CPI) Consumer Prices (CPI): are a measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rates represent the inflation rate.
Dow Jones US Select REIT Index: A benchmark of US REITs and REIT-like securities that screens for market capitalization, liquidity and percentage of revenue derived from ownership and operation of real estate securities. It is float market cap weighted and quoted in dollars.
LBMA Gold Price: The LBMA Gold Price is determined twice each business day (10:30 a.m. and 3:00 p.m. London time) by the participants in a physically settled, electronic and tradable auction administered by the ICE Benchmark Administration Ltd (IBA) using a bidding process that determines the price of gold by matching buy and sell orders submitted by the participants for the applicable auction time.
MSCI EAFE Index: An equities benchmark that captures large- and mid-cap representation across developed market countries around the world, excluding the US and Canada.
MSCI Emerging Markets Index: The MSCI Emerging Markets Index captures large and mid-cap representation across 23 emerging markets countries. With 834 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
Standard Deviation: Measures the historical dispersion of a security, fund or index around an average. Investors use standard deviation to measure expected risk or volatility, and a higher standard deviation means the security has tended to show higher volatility or price swings in the past.
Commodities and commodity-index linked securities may be affected by changes in overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes, or political and regulatory developments, as well as trading activity of speculators and arbitrageurs in the underlying commodities. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs. Diversification does not ensure a profit or guarantee against loss. Investing in commodities entails significant risk and is not appropriate for all investors. There can be no assurance that a liquid market will be maintained for ETF shares. The World Gold Council name and logo are a registered trademark and used with the permission of the World Gold Council pursuant to a license agreement. The World Gold Council is not responsible for the content of, and is not liable for the use of or reliance on, this material.